Ratings Agencies Downgrade on Kentucky's Pension Woe

The state of Kentucky has been downgraded by S&P and Moody's, spurring calls for reform to its vastly underfunded pension system.

(February 6, 2013) – There was nothing ambiguous or complicated about Standard & Poor’s (S&P) reasoning behind downgrading Kentucky. 

"The outlook revision reflects our concern over pension funded levels, which have declined and are likely to continue declining due to lower-than-actuarially required funding of pension liabilities, and budgetary pressures associated with funding post-retirement benefits," wrote S&P Credit Analyst John Sugden in the revised rating note. 

The state (or “Commonwealth of Kentucky” in official ratings’ parlance) issued $153.5 million in bonds on February 1 to fund the healthcare benefit contributions to the teachers’ pension system. All three ratings major ratings agencies downgraded the state on this latest issuance. According to Moody’s, this rating carries more weight than just an assessment for specific bonds; it “represents the state’s implicit general obligation rating.” 

Falling in Moody’s books from Aa3 to Aa2, as Kentucky has, will make the cash-strapped state’s borrowing more expensive. The agency furthermore gave Kentucky a negative outlook due to continuing fiscal stress related to the economic downturn, a large and growing unfunded pension liability, and the state’s reliance on closing funding gaps by borrowing money. 

In December, a trustee of the $4 billion Kentucky Employees Retirement System (KERS) reported from a board meeting that its funded ratio had dropped to $24.5%, making it America’s worst-funded pension system. Illinois had previously held that distinction. The fund’s latest annual report puts the figure at 27.3%, as of June 30, 2012. 

The KERS’ Executive Director William Thielen acknowledged the system’s poor funding status in his letter to trustees and members in the annual report. “Funding ratios have fallen both steadily and significantly over the last decade as a result of unfavorable market conditions, higher than anticipated retirement rates, employer underfunding … and increased expenses for annual cost of living adjustments that are not pre-funded by the employers,” Thielen wrote. 

Unfortunately for the pension fund and state’s credit rating, things will likely get worse before they get better: “While improved market conditions and the increased funding in the KERS and SPRS [State Police Retirement Systems] plans have slowed the growth of the unfunded liabilities of the various systems, KRS uses a five-year smoothing method and the full effects of the market losses in 2008 and 2009 will not be realized for another two years.” 

Moody’s specified in its adjustment note that “failure to address declining pension system funded levels” could make the state’s credit rating drop even further. 

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