State official says Kentucky pension bill won’t increase liabilities

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A pension relief bill Kentucky Gov. Matt Bevin signed into law in July won’t have the negative impact on the state’s own liabilities that municipal experts and analysts suggest, a state official said.

House Bill 1 went into effect on July 24, lowering the contribution rates of 118 agencies that participate in the Kentucky Employees Retirement System Non-Hazardous Plan to 49.47% of covered payroll instead of the actuarially required rate of 83.43% in fiscal 2020, avoiding a rate increase that some agencies said could have forced them into insolvency.

HB 1 also gives agencies such as universities and local health departments the option of leaving the pension system and paying their unfunded liabilities over 30 years.

The lower contribution rate is expected to save the agencies $121 million in 2020 and beyond, money that won't flow into the already poorly funded pension system.

The predicted underfunding is a mischaracterization of the legislation’s impact because the state has a built-in “risk margin,” said David L. Eager, executive director of the Kentucky Retirement Systems.

“Each agency has a share of the unfunded liability,” Eager said. “It is calculated using the very conservative interest rate assumption of 5.25%.”

The interest rate used by the state is one of the lowest rates, if not the lowest, in the country, he said, adding that “it causes the liability to be conservatively stated at a high level.”

Before HB 1 was passed, when an agency wanted to leave the pension system, Eager said the state’s actuary was required to calculate the liability using the 30-year Treasury rate, which fell under 2% this month. That caused the buyout cost to the agency to be “substantially higher than the real liability,” Eager said.

The reason for using the lower interest rate was to give KRS a “risk margin” for protection against the possibility of an adverse experience, such as in lower interest earnings and changes in mortality rates, versus the state’s actuarial assumptions, he said.

“The actuarial analysis would say HB 1 cost the KRS $2 million because compared to current statutes we got $2 million less,” said Eager. “In reality it simply reduced the risk margin by $2 million still leaving us a risk margin of $9 million.”

Agencies that leave KERS will have to pay their unfunded liabilities, which are earned but yet-unfunded benefits, in either a lump sum or in installments.

If an agency is unable to pay the full obligation over a 30-year period, Eager said the actuary will calculate the anticipated shortfall and adjust the contribution rate of all 1,300-plus state funded agencies upward to cover that shortfall.

“Again, it will have no adverse effect on KRS,” he said.

On Tuesday, Kentucky Auditor Mike Harmon released a report on an examination of KRS, the Teachers’ Retirement System of Kentucky and the Judicial Form Retirement System.

Harmon said the systems failed to comply with a state law passed two years ago requiring increased transparency. He questioned the inconsistent posting of investment manager contracts, allowing redactions in contracts to be made by external managers, and he said more details should be released about the carried interest on investments and posted on websites for the public.

“With the tremendous amount of attention that has been given in recent years to our public retirement systems, stakeholders and taxpayers have a right to know how funds are being invested and who is investing them,” Harmon said.

Eager was critical of the report and said it was conducted by people who “failed to understand” industry practices. He also said it took 14 months to complete, yet his agency was given three days to respond to its findings.

When the 2017 law was passed, Eager said KRS had about 140 contracts with limited partners and investors such as private equity and real estate firms, and those contracts had confidentiality clauses. KRS’ allocations in the closed-end and finite or extended maturity arrangements range from 7% to 10%. KRS can’t dictate what can and can’t be done in terms of disclosure in the existing contracts, he said.

“To be allowed to put a contract on our website we have to get the approval of all other investors in each of the limited partnerships,” said Eager. “Going forward, we are requiring the ability to post the contract on the website or we’ll say no, we cannot invest in that.”

He also said managers will redact information that they believe is confidential.

“The auditor says we should be the ones redacting information,” Eager said, adding that could open the pension systems up to lawsuits if the redaction doesn’t suit investors.

Eager also said that he has a 2016 attorney general’s opinion stating that general managers have the right to redact information.

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Pension reform State budgets Public pensions Matt Bevin State of Kentucky Kentucky