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By Kevin Wheatley
The State Journal
Kentucky’s next pension headache is closer than you think.
The Kentucky Retirement Systems has generated its share of headlines with the underfunded pension plan for state workers. But, the Kentucky Teachers’ Retirement System will need some attention from officials and lawmakers as new accounting standards take effect and cause the system’s reported unfunded liabilities to nearly double by the start of the 2015 fiscal year July 1, from $13.9 billion to $21.9 billion, according to KTRS Executive Secretary Gary Harbin.
The system for 141,520 active and retired teachers isn’t at risk of failure, but Harbin says KTRS’s current assumed rate of investment returns of 7.5 percent will drop to slightly more than 5 percent without a funding mechanism to meet rising actuarially required pension contributions, due to the new Government Accounting Standards Board rule.
His pleas for $873 million in pension obligation bonds in the biennial budget went unheeded. Now, Auditor Adam Edelen is sounding the alarm in an unprecedented step, pausing an ongoing audit in June to discuss some findings and potential solutions to maintain the pension system’s solvency.
Edelen’s audit, mandated by law, is scheduled for release this December, but with billions of dollars in unfunded liabilities at stake, that’s not a grenade he wants to unpin a month before lawmakers convene the 2015 session.
And while bond analysts say the GASB rules will not immediately affect the state’s bond ratings, KTRS and its 51.9 percent funded status remains on their radar.
Unprepared for magnitude
The state’s policymakers face “a difficult set of choices” regarding the teachers’ pension system, Edelen said in an interview last week.
He declined to discuss specific issues his office has uncovered thus far in its audit of the pension system, but he said issues facing KTRS are “real and substantive” and will not improve if left unaddressed. Edelen also brushed aside questions on potential solutions to the pension system’s funding woes, but he said the state would need to take significant steps to shore up the system.
“I do think that this is an extraordinarily complicated and difficult policy challenge, and I think I’m going to give much of the legislature the benefit of the doubt in that they trust me and my office to establish what the landscape is, what the facts are, and math doesn’t lie,” Edelen said.
Of the 58,967 active teachers in KTRS as of December, 14,991 had at least 27 years in the pension system, according to data provided by Harbin. That means more than a quarter of Kentucky’s public school teachers are eligible for retirement.
“We rely on schoolteachers to make sure that every single kid gets a world-class education, which means you want to be able to recruit the best and the brightest into the profession,” Edelen said, “and when you have a retirement system that isn’t solvent, it really hampers your ability to recruit people into the teaching profession.”
Gov. Steve Beshear said a number of groups, including teachers and retired educators, are concerned with KTRS’s solvency. He noted pension reforms for KRS passed in 2008 came after “an exhaustive look at the entire program, not just the balance sheet.”
“We found that a comprehensive look at all the elements of the pension program — including benefits, health care costs, investments, future hires and system governance — provided us with an opportunity for a holistic solution, not just a short-term fix,” Beshear said in a statement emailed to The State Journal. “Last year, the legislature passed a funding mechanism for the reforms we passed to ensure that we met the goals of the reform package. A similar approach for KTRS may prove helpful.”
Similarly, a special pension reform panel examined the effects of adopting a new retirement plan for new hires before moving to a hybrid cash balance system last session.
Filling the coffers
Advocates say KTRS needs a revenue influx to stay on solid footing, and there are a handful of options.
Harbin continues to press for pension obligation bonds, which he called a “smarter way” to address the funding issue. He points to KTRS’s success so far reinvesting some $800 million in bond sales, now worth more than $1.1 billion thanks to double-digit investment returns in recent years.
KTRS investments had gained 19.7 percent over a one-year period as of Dec. 31 and 13.4 percent over five years, according to figures provided by Harbin. Last year’s results placed KTRS among the top 4 percent of pension plans in the U.S. in terms of investment performance, Harbin said, arguing the current market is ideal for another bond sale.
“You have to pick your moments to do this,” he said. “This appears to be one of those moments that would be a good time to do this.”
Kentucky Education Association President Stephanie Winkler said KTRS’s funding troubles could afford the General Assembly an opportunity to explore tax reform, a typically thorny issue among lawmakers.
“The only way we’re going to be able to sustain our retirement for our educators is through new revenue, and we need to have comprehensive tax reform in order to accomplish that,” Winkler said in a phone interview.
Passing such a tax reform package is easier said than done given the political climate in the Capitol, she said, noting Beshear’s 2012 blue-ribbon tax reform commission that offered a number of recommendations.
Beshear wrote a plan titled “Kentucky Competes” during last year’s session, but the wide-ranging proposal never gained traction with lawmakers.
Whatever solutions are reached, bond-rating agencies will continue to monitor Kentucky’s progress. Standard & Poor’s has issued a AA-minus credit rating for Kentucky, with sizeable unfunded pension debt a heavy factor in the agency’s negative outlook for the commonwealth.
“In our view, the changes to pension liabilities resulting from the new GASB standards, such as the use of the blended rate, are more likely to affect governments for which we have already factored their weak pension funding status into our ratings,” Alex Ortolani, Standard & Poor’s communication manager, said in an email. “We will continue to differentiate states’ credit profiles where pension liabilities are large and growing, there is limited funding discipline and progress, and there has been limited action on reform.”
Once the state identifies a funding source for the pension system, KTRS will resume assuming 7.5 percent investment returns, Harbin said, noting a number of possibilities such as bonding, tax reform and an economic boon in the state.
“All those things coupled together will give the legislature the opportunity to fund this,” he said.
But until then, expect the system’s unfunded liability to mushroom.
Editor’s note: Reprinted with permission through the Kentucky Press News Service.