Kentucky's Pension Reform is Positive: Moody's
April 5, 2013
Moody's Investors Service said Thursday said that the pension reform the Kentucky General Assembly passed on the last day of its 2013 regular session is a credit positive for the Bluegrass State.
Kentucky currently has one of the lowest funded retirement systems in the country, with funded levels of 54.5% for the Kentucky Teachers' Retirement System and 30.2% for the Kentucky Employees’ Retirement System as of June 30, said Moody's analyst Lisa Heller.
The combined unfunded liability of those two plans is more than $18.7 billion and 11.4% of gross state product, the sixth-highest of any state.
Legislators "passed landmark pension reform to stabilize the state's pension system after protracted debate," Heller said.
Two bills approved March 26 in the waning hours of session with backing from Gov. Steve Beshear support reform measures and designate sources of revenue to generate nearly $100 million a year for the annual required contribution, which the state has not fully funded in many years.
Moody's called the reforms "extensive," and said they call for using a variety of methods to reduce long-term costs, including replacing Kentucky's defined benefit plan with a defined-contribution plan for all state and local employees hired after 2013.
The state, calling it a "hybrid cash balance" plan, will establish employee accounts funded with employee and employer contributions.
The accounts are guaranteed a 4% annual return, and 75% of returns above 4%. On retirement, employees can purchase an annuity based on the value of their accounts or receive a lump sum of the employee and employer contributions. Lawmakers reserved the right to amend the plan in the future.
Annual cost of living adjustments can be approved but only if the General Assembly can pre-fund the increase.
"Kentucky's pension funding problems reflect decades of chronic underfunding, extensive early retirement incentives, and lackluster investment returns exacerbated by poorly structured reforms enacted in 2008," Moody's said.
The 2008 reforms gradually increased the state's pension contribution levels, reduced benefits for new hires, increased the period for becoming vested, and limited annual cost of living and sick leave adjustments, but lawmakers adopted a schedule that failed to reach the actuarially required contribution until 2025.
Two years ago, Moody's dropped the state's issuer rating to Aa2 from Aa1, and maintained a negative outlook because of the state's structural budget imbalance, depletion of reserves, weak and declining pension system funding, and a vulnerable economy.
In November, Fitch Ratings downgraded Kentucky's $7.6 billion of appropriation-backed debt to A-plus from AA-minus citing the state's "poorly funded pension system," along with reduced financial flexibility because of the economic downturn.
In January, Standard & Poor's revised the outlook on state's AA-minus issuer credit rating to negative from stable due to concern over pension funding levels.
Beshear said increased borrowing costs from rating downgrades were a major driver that compelled the state to act on pension reform and funding this year. He had threatened to call a special session to address pension form if necessary.
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