April 12 (Reuters) - Kentucky’s recent overhaul of its long-crippled public pension system is winning over the rating agencies that had expressed deep concerns about the state’s low retirement funding.
The Kentucky legislature passed a reform of the public pension system on March 26, and Governor Steve Beshear signed it into law on April 4.
The changes “should allow the state to better manage its underfunded pension liability and have come sooner than many expected,” Fitch Ratings said in a note on Friday.
“But, in our view, the overall challenges to the state remain, and the plan exerts additional budgetary pressure,” the rating agency added about the state’s financial condition, which it said suffers from temporary budget-balancing maneuvers and depleted reserves.
Consistently, Kentucky has put in roughly half the amount of money that actuaries suggest will make the system whole. Returns on investments typically provide the lion’s share of public pension revenues and make up 68 percent of the Kentucky retirement system’s funding. Funds from the state -- essentially the taxpayer dollars -- constitute 20 percent of the Kentucky system’s revenues and are known as the Actuarially Required Contribution, or ARC.
Under the new law, Kentucky will be required to fully fund its ARC by fiscal 2015, at a cost of about $100 million a year that is to be covered by changes to the state’s personal income tax. Kentucky will also put new hires into retirement plans similar to those provided in the private sector and essentially eliminate cost-of-living adjustments for retirees.
“We believe acceleration to the full ARC will have a positive impact on the long-term trajectory of the state’s pension liability,” Fitch said. “However, the impact of the acceleration will be muted due to the significant underfunding level.”
Last week another rating agency, Moody’s Investors Service, noted Kentucky has one of the worst funded pension systems in the country, with the sixth highest unfunded pension liability of any state. The Kentucky Employees Retirement System only has enough assets to cover 30.2 percent of its liabilities.
“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 “landmark pension reforms” are credit positive for the state, it added.
Altogether, the Pew Center on the States estimates states are short $757 billion for their pension systems. For years, many had not made their full ARCs. Then during the 2007-09 recession the stock market stopped providing sufficient returns just as states’ revenues fell and forced them to pull back further on funding.
Of late, public retirement systems have been doing better. According to the U.S. Census, pensions had assets of $2.84 trillion in the fourth quarter of 2012, the highest since a peak of $2.93 trillion in the fourth quarter of 2007.
Nonetheless, pension crises persist in many places, most notably Illinois, which currently has a shortfall of $98.6 billion.
Kentucky is one of 14 states that have only made partial pension payments over the past seven years, according to Chris Tobe, who served as a trustee of the system from 2008 through 2012. In fiscal 2011, it had investment returns of nearly 19 percent, but assets “grew by only 1 percent due to the negative cash flows from underfunding,” he said in a white paper last summer.
Almost every state has enacted pension reforms in the last five years, and political fights are erupting over the country over whether the reforms go far enough or if they are even legal. Many states only made changes to benefits for new hires, which proved too slow to solve the most pressing problems.