Heavily negotiated agreement fully funds and stabilizes pension system with revenue-neutral plan
FRANKFORT, Ky. (March 26, 2013) – After weeks of bipartisan negotiation, the General Assembly on Tuesday evening passed bills stabilizing and modernizing the state’s pension system. The pension reform plan creates funding to pay the state’s full recommended annual pension contribution without threatening key state services, such as education and public safety.
The companion bills, House Bill 440 and Senate Bill 2, passed both chambers, eliminating the need for a special session on pension reform.
“The looming pension liability threatened to gut funding for education and all other priorities. It demanded our immediate and bipartisan cooperation,” said Gov. Steve Beshear. “No matter our political philosophies, none of us were willing to put our kids at risk of a stripped-down education. We all agreed we could not simply change our pension plan without paying for it.”
The increased cost to fully fund the actuarially required contribution to the Kentucky Retirement Systems is estimated at $100 million per year from the General Fund.
Senate President Robert Stivers said the pension reform compromise is a “shining example of how government should tackle pressing problems facing the state.”
“Like any major piece of legislation, it is not without some controversy, but we have brought stability to our system and adequate funding that will ensure a safe and secure pension for those covered,” said House Speaker Greg Stumbo.
Proposed pension changes
The governor and legislators agreed to the major recommendations of the legislative Kentucky Public Pensions Task Force.
The agreement fully funds the annual increased estimated state obligation to the pension plan, known as the actuarially recommended contribution (ARC), beginning in Fiscal Year 2015.
SB2 makes fundamental changes to the pension plan in order to address long-term sustainability issues. It creates a hybrid cash-balance plan for future state and local employees hired on or after January 1, 2014, which gives those new employees better portability of their pension benefits. The hybrid plan is approximately actuarially equivalent to the existing benefit plans, and provides state and local governments with improved predictability and stability for pension costs.
The plan will provide for an annual cost-of-living adjustment for retirees if the General Assembly fully prefunds it in the year it is provided.
SB2 also improves transparency and legislative oversight of the Kentucky Retirement Systems and increases local government representation on its board.
The legislative and judicial pension systems will also make the same changes to their systems for all new participants (those elected or appointed after Jan. 1, 2014).
Funding the pension obligation
The governor and legislators agreed to adjustments to the state’s tax code that are roughly revenue neutral and will generate additional funds to pay for the increased ARC.
HB440 reduces the personal tax credit by $10 – which will generate about $32.5 million annually to the General Fund, and provides a new trade-in tax credit for the purchase of a new car.
On balance, taxpayers will see little change in the amount of taxes they pay each year.
Another $30 million will be created annually thanks to recent federal tax changes. Finally, new technology and compliance efforts will allow the state to collect taxes that are already owed in a more efficient manner, which will collect $37.4 million more each year upon full implementation.
The governor and legislative leaders worked to create an adequate funding plan to pay the increased ARC that would not force cuts in other critical state services such as education, public safety and health care.
Despite repeated budget cuts, the governor has worked with legislators to protect these services from the worst of the reductions over the past five years. Without a funding plan, the growing pension liability would have crowded out other services for an ever-larger share of the General Fund.
The unfunded liability for Kentucky Retirement Systems, which includes state and local employees, is estimated to be approximately $18 billion. That’s the same size as an entire biennial state General Fund budget.
It was this growing pension liability that caused concern to the national bond rating agencies. In February, Standard and Poor’s Rating Services revised Kentucky’s financial outlook from stable to negative, citing the unfunded pension liability as a primary reason. A year ago, Moody’s Investor Service downgraded Kentucky’s bonds and maintained a negative outlook, citing in part the growing pension liability. A downgrade in bond rating means it costs taxpayers more for public building projects, as it increases the borrowing costs.
The pension reform agreement will also improve transparency for taxpayers through the creation of a website that updates the financial and actuarial health of the system. Stronger legislative oversight will be accomplished through the creation of the Public Pension Oversight Board to monitor the Kentucky Retirement Systems. Pension board membership will expand from nine members to 13, with three new members from nominees from the Kentucky Association of Counties, the Kentucky League of Cities, and the Kentucky School Boards Association; and a fourth new member elected from CERS.