S&P: Kentucky?s pension funding ratios weak despite improvements

BY SourceMedia | MUNICIPAL | 06/03/21 10:46 AM EDT By Chip Barnett

Kentucky has taken action to shore up its pension system, but it?s going to take time to reverse the adverse effects of past funding shortfalls, according to S&P Global Ratings.

Kentucky has one of the poorest funded pension systems among all U.S. states, with an aggregate funded ratio of 44% as of fiscal 2019, S&P said. The state?s general obligations are rated A by S&P with a stable outlook.

The state?s Public Pensions Authority is responsible for the Kentucky Employees Retirement System (KERS) and State Police Retirement System (SPRS) while counties and cities are responsible for the County Employees Retirement System (CERS). The Teachers Retirement System is a seperate system with its own board.

The funded ratios for the systems are 14.01% for the KERS non-hazardous and 55.18% for the KERS hazardous, 58.27% for the TRS, 28.02% for the SPRS and 47.81% for CERS non-hazardous and 44.11% for the CERS hazardous.

"KERS non-hazardous is the largest plan and is, arguably, the lowest funded state pension plan in the country at just 14%, and was on pace to fully exhaust its assets by 2023 before the recent adjustments allowed it to make funding progress," S&P said.

?For years, Kentucky used aggressive assumptions and methods that led to contributions not generating pension funding progress. As a result, the funded ratios for the major pension plans in the commonwealth are weak," S&P analysts wrote in a report May 25. "Recently, the plans have made changes to assumptions and methods, most of which we view as positive adjustments. However, these adjustments will require larger contributions that could create budgetary pressure."

S&P said due to the changes, costs will likely increase to fund the deficiency, adding those local governments that can?t make budget adjustments for increasing pension costs will likely be financially pressured.

?Our view that many cities and counties will potentially face rating pressure from escalating pension costs is supported by generally unfavorable revenue flexibility, outside of the few areas with high wealth levels,? the report said.

?Local governments participate in the poorly funded [CERS] a cost-sharing multiple-employer statewide plan, and we expect the payment stress from this plan will rise for local governments,? S&P said. ?This will pressure their credit quality as local governments cover all payments and hold the liability.?

And these pension costs will likely rise considerably.

Over the past 20 years, Kentucky didn?t make the full actuarially determined contributions to its pension systems and used aggressive assumptions and methods, which led to funding levels falling to some of the lowest in the country.

In 2017, the systems started using more conservative assumptions that led to higher contribution requirements and the state made budgetary adjustments to pay the full ADC to its plans. But even with these changes, poor funding levels will likely persist for years as the plans' funded ratios remain extremely low, according to S&P.

If contributions do not increase, unfunded liabilities will likely rise for CERS and TRS.

In March, the state Legislature overrode a veto from Gov. Andy Beshear and created a hybrid pension structure for teachers hired after Jan. 1, 2022.

"This hybrid plan will be a partially defined-benefit plan (like the existing pension plan) and part defined-contribution plan, akin to a 401(k)," according to the National Public Pension Coalition. "What will that mean for those workers? They'll have to contribute more towards their retirement benefits and will have to work at least 30 years, a change from the current minimum of 27 years. The state's obligation will be capped at 10% of the workers' salary."

The bill passed the House on a 68-28 vote on Feb. 4 and passed the Senate on a 25-11 vote on March 15. It was vetoed by the governor on March 24 and both the House and Senate overrode the veto on March 29.

?This change will reduce new benefit accruals, but meaningful savings will take time to materialize, given the current size of the plan's unfunded liabilities,? S&P said.

According to Moody?s Investors Service, the new hybrid plan is a credit positive for the state.

Moody?s assigns an Aa3 rating to Kentucky with a stable outlook while Kroll Bond Rating Agency rates the state AA-minus with a stable outlook.

Last month, Fitch Ratings revised Kentucky?s outlook to stable from negative due to the state?s solid economic recovery from the COVID-19 pandemic. Fitch also affirmed the state?s issuer default rating at AA-minus.

One bright spot is that other postemployment benefits at the state level are better funded than most other state plans. However, S&P said that risks remain due to the volatility of healthcare costs.

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Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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