Ruling on a Kentucky pension plan viewed as credit positive for state

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A Kentucky Supreme Court ruling preventing a quasi-governmental agency from leaving the state-run pension system is credit positive, Moody's Investors Service said.

The ruling “greatly reduces” the likelihood that Seven Counties Services Inc., a nonprofit quasi-governmental agency that provides mental health services in the Louisville area, and others like it, can walk away from their obligations to the Kentucky Employees' Retirement System's non-hazardous plan, according to Moody’s analyst Thomas Aaron.

“The commonwealth's practical obligation to continue providing material support for many quasi-governmental agencies' elevated pension costs will remain,” Aaron said.

Seven Counties filed for Chapter 11 bankruptcy protection in 2013 in an attempt to shed its escalating costs in the non-hazardous multiple-employer cost-sharing retirement system.

The KERS non-hazardous plan has pension assets sufficient to cover only two years of benefit payments, assuming no future contributions or investment income, and a reported funding ratio of 13% as of June 2018, Moody’s said.

After filing for bankruptcy, Aaron said “numerous points of legal contention followed, related to whether Seven Counties could use bankruptcy to walk away from KERS and its share of the system's unfunded liabilities,” which was more than $90 million in 2013.

Until the Kentucky Supreme Court’s unanimous ruling on Aug. 29, Seven Counties' strategy had been successful, said Aaron.

Both the bankruptcy and U.S. district courts involved in the case determined that Seven Counties could reject its executory contract, ending its participation in KERS. The case stalled at the federal appellate level in late 2018 to allow the Supreme Court to rule on the nature of the relationship between Seven Counties and KERS.

“Now that the state's highest court has ruled that the relationship is statutory, not contractual, the federal appellate court will likely rule that Seven Counties cannot use bankruptcy to cease participation in KERS, because there is not a contractual relationship for it to reject,” Aaron said.

Seven Counties’ case now returns to the Sixth Circuit Court of Appeals for resolution.

Because of the highly unfunded position of the KERS non-hazardous plan, Aaron said the required contributions of participating employers have risen sharply over the past decade.

In 2013 participating entities' required contributions for pension and retiree healthcare benefits combined were 24% of payroll, up from a low point of around 4% of payroll in 2003. To maintain the system's solvency, contribution rates charged to participating employers rose to 49% of payroll in fiscal 2018 and 83% of payroll for fiscals 2019 and 2020.

Acknowledging that many of its quasi-governmental agencies couldn’t afford to operate with contributions that amounted to 83% of payroll, and that these costs would likely cause more bankruptcies if imposed, Kentucky granted numerous entities temporary cost reprieves, including a freeze of contribution rates at 49% of payroll for fiscal years 2019 and 2020, Moody’s said.

In conjunction with the contribution rate freeze for the current fiscal year that will end in June 2020, Kentucky recently extended to the numerous agencies that participate in KERS and certain other statewide retirement systems the opportunity to buy out of the pension system at a market value discount under the condition that they collateralize their future funding commitments.

“With the court's decision in all likelihood blocking bankruptcy as a mechanism for these entities to attain pension cost relief, the recent buyout opportunity offered by the state may be preferable to the other available alternative, contribution requirements that will exceed 80% of payroll beginning in July 2020,” Aaron said.

In a Sept. 5 report on possible asset depletion by some public pension plans, S&P Global Ratings said KERS non-hazardous plan had the lowest funded ratio at 12.8% followed by the Chicago police pension plan at 21.8%.

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