States take action to ease pension funding dilemma

Several states, including Colorado, Illinois, Kentucky and Minnesota, are taking steps to mitigate their respective pension funding crises.

Although the legislative remedies differ, recurring measures in many of the bills include direct contributions from the states themselves, increasing participant contribution rates and capping cost-of-living adjustments.

Experts agreed that underfunded state plans are a national crisis but also pointed out that the problem is best solved by the individual states.

"Each state's system is unique, so I don't think there's a federal solution, nor am I aware of any of my brothers in the pension system asking for one," said Ron Baker, interim executive director of the $48 billion Colorado Public Employees' Retirement Association, Denver. "It's a local issue, and we're not asking for federal help for what works best in every state or municipality."

Colorado Gov. John W. Hickenlooper Jr. signed into law on June 4 a pension reform bill designed to reduce investment risk and improve the funded status of the state's public employee retirement system. Among other things, the law increases the contribution rate for most Colorado PERA participants and directs the state to allocate $225 million each year to the pension fund to reduce its unfunded liability. Colorado's pension funding ratio was 46% as of 2016, the fifth lowest in the U.S., according to data from Bloomberg.

"We were projected to be ... 20% funded in 40 years," Mr. Baker said. "We weren't projected to be out of money, but something needed to be done to be fully funded within 30 years."

Mr. Baker also pointed out that credit ratings agencies had warned Colorado a credit downgrade was possible if a solution wasn't found. "It was important not just for the pension plan, but for the broader state of Colorado," he said.

Because of the changes, Mr. Baker said he expects PERA's soon to-be-released financial statements to show that all five of its divisions are on track to be fully funded in 30 years.

In Kentucky, a signed pension reform bill has led to an extended fight between the offices of the governor and state's attorney general.

Kentucky Gov. Matt Bevin on April 10 signed Senate Bill 151, designed to solve the state's pension funding crisis. Data from Bloomberg show that Kentucky's pension funding ratio was 31.4% in 2016, the second worst in the nation behind New Jersey.

David Eager, executive director of the Kentucky Retirement Systems, said the state's crisis was the result of several factors, including the Legislature not approving the recommended contribution. In addition, the recommended contribution was set too low by actuaries.

"So we didn't get what we asked for, but what we asked for was insufficient," Mr. Eager said, adding that "recent market declines did not help."

Under the new pension legislation, teachers hired after Jan. 1, 2019, will accrue benefits from a cash balance plan instead of the existing defined benefit plan at the $18.1 billion Kentucky Teachers' Retirement System, Frankfort. Cash balance plans also will be maintained for current and future employees who make up the separate $17.4 billion Kentucky Retirement Systems, Frankfort.

But the day after the bill was signed, Kentucky Attorney General Andy Beshear, the Kentucky Education Association and the Kentucky State Fraternal Order of Police filed a lawsuit, arguing the law reduced workers' rights and benefits and was passed unconstitutionally.

On June 20, a state judge struck down Kentucky's pension reform law as unconstitutional.

On June 21, Mr. Eager told Pensions & Investments in an email that the governor plans to appeal the decision and that KRS will "continue to work to be able to implement the (pension reforms) if the courts give us the go ahead."

In Minnesota, enacting pension reform proved far less contentious. The state's 2018 omnibus pension bill, signed into law on May 31 by Gov. Mark Dayton, will reduce four of its public pension plans' rate-of-return assumptions to 7.5%.

The $28.7 billion Minnesota Public Employees Retirement Association, $22 billion Minnesota State Retirement System and $956 million St. Paul Teachers' Retirement Fund Association, all of St. Paul, will have their assumptions lowered from 8%, while the $20 billion Minnesota Teachers Retirement Association, St. Paul, will have its return assumption lowered from 8.5%.

Cost-of living increases, currently varied by plan, would be reduced to 1.5% after five years for the three state plans. For the St. Paul teachers' plan, COLAs would be eliminated for two years and thereafter be set annually at 1%.

Employee contribution rates will increase by a range of 0.25% to 1% of pay by fiscal year 2020, while employer contribution increases will range from 0.75% to 2.5% of pay. The changes will mean total savings of $6.1 billion over the next 30 years. Minnesota's pension funding ratio was 53.2% in 2016, the seventh worst in the U.S.

In Illinois, the state's General Assembly approved a budget bill May 31 that includes a voluntary buyout program for participants in the state's pension plans.

The state's five pension funds faced $137 billion in unfunded liabilities combined as of June 30, 2016. Illinois' pension funding ratio was 35.6% in 2016, the third lowest in the U.S.

In a news release, Gov. Bruce Rauner called the bill "a step in the right direction, though it does not include much-needed debt paydown and reforms that would reduce taxes, grow our economy, create jobs and raise family incomes." Mr. Rauner indicated in the news release that he intends to sign the bill.

The passage of these bills follows efforts last year by Connecticut, Michigan and Pennsylvania that involved either passage of pension reform laws or budgets with pension funding provisions.

Investment consultants said when large public pension plans, particularly state plans, face funding crises, it's rarely because they had a few years of weak returns. In fact, the reason most states face underfunding issues is almost always because of the funding itself, they said.

"Investments for the most part have not been the problem. It's the underfunding," said Jay V. Kloepfer, executive vice president and director of capital markets and alternatives research at Callan LLC, San Francisco. "You can only do so much on the investment side. They didn't put enough money in over the years and it caught up to them."