Pension bonds a gamble

Issuing $1 billion in pension bonds, as narrowly approved by the Kansas House Wednesday and as the Senate likely will approve Thursday, would give the state’s pension plan a boost but should make taxpayers and credit-rating agencies nervous.

Gov. Sam Brownback had originally proposed issuing $1.5 billion in pension bonds and extending from 2033 to 2043 the scheduled date for eliminating the Kansas Public Employees Retirement System’s unfunded liability. His goal was to significantly reduce state payments to KPERS, which would help the state’s budget deficits – but would cost taxpayers billions of dollars more over the next 30 years.

Lawmakers backed off that proposal somewhat. A conference committee reduced the bond amount to $1 billion and kept 2033 as the target date for fully funding KPERS.

The $1 billion infusion of cash would improve KPERS’ current funding ratio from 60.7 to 65.8 percent. The state general fund, not KPERS, would be responsible for repaying the bonds and interest, which would cost about $60 million a year, or about $1.8 billion.

The state expects to sell the bonds at an interest rate of about 4.4 percent and earn an average return of 8 percent from investing the $1 billion. If that happens – a big “if” – a spread of about $327 million (present value) between the earnings and the interest costs would enable the state to reduce its contributions to KPERS.

Per the plan, the state would lower its required contribution next fiscal year by about $6 million (counting the $60 million it might spend on debt service of the bonds). In fiscal year 2017, it would contribute about $69 million less than currently required. After that, the contribution rate would be adjusted to what is necessary to eliminate the unfunded liability by 2033.

KPERS doesn’t have much to lose, as it gets $1 billion to invest and the state has to pay back the bonds. But from the state’s perspective – including its taxpayers – borrowing money to invest is a risk.

If the stock market drops again – as many predict, given its recent record highs – the state could end up paying more in interest costs than what KPERS earns in investment income.

State leaders downplay that risk. They note that KPERS has averaged an 8 percent return during the past 25 years. Also, the state borrowed and invested $500 million in 2004, and it has so far beaten its spread.

But the other concern is the credit-rating agencies. Some analysts see pension debt offerings as a sign of distress. For example, debt tied to pensions played a role in the bankruptcies of Detroit and Stockton, Calif. Another credit downgrade for Kansas could be costly.

The borrowing might pay off. But make no mistake – it’s a big gamble.

For the editorial board, Phillip Brownlee

This story was originally published April 1, 2015 at 7:07 PM with the headline "Pension bonds a gamble."