“The changes passed by the Kentucky legislature should allow the state to better manage its underfunded pension liability and have come sooner than many expected,” Eric Kim, Fitch Ratings’ director of U.S. Public Finance wrote in an analysis. “But, in our view, the overall challenges to the state remain, and the plan exerts additional budgetary pressure.”
The reform requires the state to begin fully funding its actuarially calculated annual required contribution (ARC) into the Kentucky Retirement System by 2015, a timeline faster than observers had anticipated. The state has taken breaks or underfunded its retirement plan for years, which has led to its status as one of the worst-funded systems in the country. In fiscal 2012, the state funded $251 million of the $482 million ARC. The state’s biggest employee retirement fund, Kentucky Employee Retirement System, is less than 30 percent funded and accounts for $11.2 billion of the system’s $33 billion total unfunded liability.
To help pay for ramping up the ARC, the legislature also made several tax law changes, including reducing a personal income tax credit, which are projected to generate $100 million a year, according to Fitch. The acceleration of fully funding the ARC will have a “positive impact on the long-term trajectory of the state's pension liability,” Kim said. But, given that Kentucky’s funded ratio has declined every year since 2001, it has a lot of ground to make up and even with the acceleration, a stable funded ratio will not happen quickly.
Additionally, Kim noted, the Bluegrass State has other budgetary pressures that could make it difficult to fund its pensions, including increasing health and other benefits for retired workers.
The new pension law was passed by lawmakers on the last day of the session in March and signed by Gov. Steve Beshear this month. It also created a 401(k)-style plan for new workers, mandates that any cost-of-living adjustments must be pre-funded, and expands the pension board’s membership to 13 members from nine. The new hybrid retirement system for future hires would guarantee a 4 percent return while basing additional benefits on investment performance.
