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Pension reform flexibility affects government credit quality
Source: Moody’s Investors Service

 

Financial pressure from pensions, other expenditure needs and slow revenue growth has
prompted many state and local governments to attempt pension benefit reforms. State court
decisions that uphold or overturn reform efforts, and the extent to which benefit changes
are an option for improving pension funding, can significantly affect the credit quality of
governments within a given state. The pace of legislative reform efforts and corresponding
judicial decisions is elevated and ongoing across the country.

Key legal questions often center on the flexibility to alter prospective benefits
for current employees and/or cost-of-living adjustments (COLAs) for current
employees and retirees. Benefit changes that affect only new employees generally take
years to produce material savings. Some governments, such as the State of New York (Aa1
stable), are limited by their state constitutions to only these types of changes. Courts have
decided that other governments, such as Oregon (Aa1 stable), may not impair accrued
benefits, but can reduce prospective benefit and COLA accruals for current employees.

Judicial decisions on benefit changes can have material credit effects for
governments. For example, the State of New Jersey (A3 stable) averted a substantial
liability increase in 2016 when its highest court upheld a COLA suspension, while Arizona
(Aa2 stable) governments face substantial pension cost increases associated with two legal
decisions by the state’s Supreme Court. A ruling on the breadth of constitutional pension
benefit protections by the Illinois (Baa3 negative) Supreme Court was a driving factor
when we lowered the City of Chicago’s (Ba1 negative) rating below investment grade.

Legal flexibility to achieve reforms does not necessarily translate into practical
feasibility or political willingness to curtail liabilities. Governments such as the
State of Ohio (Aa1 stable) and the City of Dallas (A1 negative) have implemented
pension benefit reforms to avoid or limit rapidly growing costs. The extent to which these
governments can rely on additional reforms to prevent pensions from pressuring budgets
in the future is uncertain. Conversely, facing a legal prohibition, the State of Arizona
obtained voter approval for a constitutional amendment that enabled modest changes to
certain COLA-type benefits.

New strategies unrelated to benefit changes are gaining momentum, with varying
credit impact. The City of Jacksonville, FL (Aa2 stable), among others, has sought to
address rising pension liabilities and costs with dedicated, future revenue streams. The
State of Missouri (Aaa stable), for example, is seeking liability reductions through voluntary
buyout offers.

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