States move along different roads to tackle underfunding dilemma

More states are enacting measures to help improve the solvency of their public pension funds as funding ratios remain low.

While pension reform is not a new phenomenon — 43 states enacted retirement plan changes between 2009 and 2011, according to the National Conference of State Legislatures — states are taking different paths, including efforts to move to cash balance plans, alter cost-of-living adjustments or shore up funds through alternative revenue sources.

“There's been a lot (of pension reform) on the table and every state has approached this differently,” said Chris Mier, managing director at Chicago-based Loop Capital Markets LLC, an investment services firm that tracks public pension funding every year. “I think 30 states are in roughly good shape, but there are probably five that need to get going. I don't view this as a systemic problem; I view this as a state problem.”

Among the entities making changes this year are Kentucky, Puerto Rico, Florida, Kansas and Maryland.

Kentucky, which has about $18 billion in unfunded public pension liabilities, passed legislation on March 26 that will develop a cash balance plan for state and local employees hired on or after Jan. 1, 2014. Under the new plan, employees also will be able to purchase an annuity or receive a lump-sum payment on retirement.

“The most significant reason for passing the legislation was to address the underfunding problem in at least two of the plans we administer,” said William Thielen, executive director of the Kentucky Retirement Systems, Frankfort, which oversees the state's five pension plans with $10.9 billion in assets. “For 14 out of the last 21 years, (the Kentucky General Assembly) has not put in the actuarially required contributions.”

The two most underfunded of the state's plans are the Kentucky Employees Retirement System (non-hazardous plan), which was 27.3% funded as of June 30, 2012, with $11 billion in liabilities and $3 billion in assets; while the Kentucky State Police Retirement System was 40.1% funded as of the same date, with $648 million in liabilities and $260 million in assets.

The law will generate the $100 million a year needed to fully cover actuarially required contributions through changes in the tax code and reducing the personal tax credit by $10.

Another provision of the law requires a cost-of-living adjustment to be fully prefunded by the General Assembly in the year it is provided, which “essentially eliminates” them, according to Mr. Thielen.

“It's not something that was desired from the standpoint of retirees, but I think everyone realized the necessity,” he said.

According to Loop Capital's annual Public Pension Funding Review, the changes to defined benefit plans that are met with the highest level of opposition from employees and retirees are eliminating the COLA and moving to a cash balance plan, followed by increasing the retirement age, increasing contribution rates, and reducing disability and death benefits. But Mr. Mier said the most controversial changes can sometimes be the most effective, too.

“The trade-off you face is, "Do I want to solve the problem in the shorter term or the longer term?'” Mr. Mier said. “Migrating to a DC plan doesn't give you an upfront benefit, but it gradually happens.”

Puerto Rico opted to overhaul its cash-strapped public pension fund by keeping the defined benefit plan but making significant changes to funding requirements and retirement age.

The law, effective July 1, 2013, will increase employee contributions to 10% from 8.275% of pay, increase the retirement age for some workers, and lower future monthly pensions and benefits.

The Puerto Rico Employees Retirement System, San Juan, has a funding ratio of 6.8%. That, coupled with the government's budget deficits, led to the downgrading of Puerto Rico's bond ratings to just above junk-bond status by all three major credit ratings agencies.

At the other end of the scale, pending legislation in Florida would close the Florida Retirement System's defined benefit plan to some employees and move all new employees to a 401(a) plan. The legislation was voted out of committee and is scheduled to go before the full Senate the week of April 15.

The measure would also offer an incentive for current employees to enroll in the 401(a) plan by reducing required contributions to 2% from 3% of pay, and requiring the state to contribute an extra 1%. The vesting period for the DB plan, also would be increased to 10 years from eight years.

Instead of making direct changes to the Kansas Public Employees Retirement System, the state is trying to shore up the fund through alternative methods.

A bill will be taken up by the full state Senate on May 8 that would allow Kansas to borrow $1.5 billion, through the sale of taxable bonds, to help fund pension obligations.

This is not the first time the state has generated revenue for pension relief: last year, Kansas used $47 million in casino proceeds to help fund its ailing pension system.

The funding ratio was 59% with $9.2 billion in unfunded liabilities as of Dec. 31, 2011.

Maryland recently passed a law that would change the way contribution rates are calculated.

Last week, the Maryland General Assembly passed and sent to the governor for signature a bill that would gradually eliminate the current “corridor method” of funding the $40.2 billion Maryland State Retirement and Pension System. Under these calculations, which were adopted in 2002, Maryland could maintain its contribution rate from the previous year as long as the funding ratio remained between 90% and 110%. If the funding ratio dipped below 90%, the contribution rate would equal the previous year's rate plus 20% of the difference between the actuarially required contribution and the previous year's rate.

The new measure would allow Maryland to contribute $19 million less in fiscal year 2015 and save the state an estimated $450 million once the corridor method is completely phased out by 2024.

The bill also eliminates a tiered amortization period and replaces it with a closed, 25-year amortization.

The funded status of the six pension funds in the Maryland system was a combined 64.4% as of June 30. Only the $329 million judges' pension fund was more than 70% funded, at 78.4%.

“The Legislature has taken a very important step in eliminating a funding method that has contributed to an underfunding of the system,” Nancy K. Kopp, state treasurer and chair of the pension system board of trustees, said in a statement. “

But not every pension reform plan meets with success.

Pennsylvania Gov. Tom Corbett put a pension reform plan in his 2014 fiscal budget in the beginning of year, but so far no legislation has been proposed. Mr. Corbett's plan would cut future benefits for current employees and move new hires into a defined contribution plan.

Illinois, despite having the worst-funded state pension plans in the country with a combined $97 billion in unfunded liabilities, has remained in political gridlock and not passed any comprehensive reform, even though several measures have been taken up by the Legislature.

“There's kind of a correlation between the size of the problem and the degree of political difficulty of instituting a solution,” Mr. Mier said. “The political problems enable the pension problem to get bigger, and vice versa.” n