Topeka Kansas lawmakers are considering an unusual plan to shore up the state's troubled pension system that amounts to borrowing $1 billion to $1.5 billion in the bond market in order to pay down a roughly $9 billion long-term funding gap.
The plan involves issuing what are called "pension obligation bonds" and investing the proceeds of those bonds into the Kansas Public Employees Trust Fund where they would yield earnings along with the trust fund's other investments.
On the other end of the deal, however, state taxpayers would be responsible for paying off the pension bonds while, at the same time, continuing to contribute into the pension system.
"It's already been done once, so it can work," said KPERS Executive Director Alan Conroy.
In 2004, the state issued $500 million in pension bonds, and it is still paying about $33 million a year out of the state general fund to retire those bonds. Those bonds were issued at 5.39 percent interest, while the KPERS fund has been earning, on average, 7.45 percent on the investments, a profit of about $174 million.
Still, that infusion of cash was not enough to address the pension fund's long-term problems, especially after the fund suffered significant losses during the Great Recession.
As of today, the fund holds about $13 billion in assets, but that is only about 60 percent of what it would actually need over the next 40 years to pay off all of the obligations it has already incurred.
In 2012, Kansas lawmakers passed a major overhaul of KPERS, increasing the contribution rate for both the state and the public employees covered in the plan. That overhaul also created a new, less generous, pension plan for new employees hired after the first of this year.
But the increased contribution rate agreed to in 2012 is now one of the factors adding to the state's current revenue shortfall, now projected at around $300 million just for the remainder of this fiscal year.
In response, Gov. Sam Brownback has proposed reducing the state's contribution for the rest of this year by about $52 million. And he is proposing the state issue $1.5 billion in pension obligation bonds which, if approved, would allow the state to continue holding its contribution rate down.
In addition, Conroy said, the fund would reach its goal of being 80 percent fully funded by 2022, about three years earlier than it would without the bond issue.
A Senate committee will hold a hearing Wednesday on one bill that would authorize $1 billion in pension bonds. A similar bill is pending in the House that would authorize $1.5 billion in bonds.
Supporters of the plan say it could save the taxpayers money over the long run because the state probably would only have to pay about 4.5 percent interest on the bonds. But it would expect to earn around 8 percent a year by investing the proceeds through the KPERS trust fund.
Financial experts say that using borrowed money to bet on interest rate spreads can be a risky venture known as "arbitrage," and public entities like state and local governments are generally not allowed to do it.
But Conroy said the proposals being considered are not "pure arbitrage" because the state would not rely on the interest earnings to make the debt payments. Instead, the debt service payments would come directly from the state general fund.
In other words, even if the state loses the bet — if, for instance, investment earnings fall below the interest rate on the bonds — the KPERS fund would still get the benefit of the cash infusion, while the payments on the bonds would come out of the state general fund.
According to information from KPERS, a $1.5 billion bond issue, at today's interest rates, would require annual payments of $90 to $95 million over 30 years, for a total of $2.7 to $2.85 billion.