Retirement System burgeoning deficit on Moody’s radar

Written by  //  May 4, 2011  //  Government  //  No comments

Retirement System Administrator Héctor Mayol (Credit: © Mauricio Pascual)

Gov. Luis Fortuño’s administration has three months to show Moody’s Investors Service that it is taking enough — and correct — action to address the Commonwealth Retirement System’s $28 billion funding shortfall to avoid a possible downgrade of its current A3 rating.

But rather than being taken aback by Moody’s decision to place the agency’s finances on watch, government officials insisted Tuesday a strategy is in place to deal with the decades-old problem the New York-based agency said is “straining public finances.”

In an interview with News is my Business, Retirement System Administrator Héctor Mayol said Moody’s is aware of the government’s short- and long-term plans to avoid insolvency and ensure that the $1 billion needed to pay the island’s 105,000 public sector retirees is available.

“Moody’s announcement could be characterized as positive because, if you read it carefully, they’re saying they were on the verge of downgrading our bonds, but are aware that we’re planning to take action to begin to fix the problem,” said Mayol, noting that 5,000 more public workers are in line to start receiving benefits July 1.

Moody’s announcement stems from the “weak funding of the pension plans and the significant strain that future pension funding requirements will likely exert on the Commonwealth’s financial position.”

“We expect to conclude our review within 90 days. During this timeframe, we will assess the Governor’s recently announced proposals for addressing the Retirement System’s underfunding, how far the proposals get toward relieving the commonwealth of the long-term budgetary pressure that has built up as a result of the historic underfunding of the system, and the long-term costs of the solutions,” Moody’s said, adding it “will assess the commonwealth’s proposed budget to determine whether it moves the commonwealth closer to structural balance, and whether we believe the revenue and expense forecasts used are reasonable.”

Mounting deficit
The Commonwealth Retirement System’s actuarial deficit has been mounting for several decades, and currently stands at 91.5 percent of its obligation, Mayol said, noting the agency has about $1.6 billion in assets, but owes nearly $17 billion. Even though there are 140,000 public employees presently contributing to the pension system, the amount is not enough to cover current and future obligations.

In April, government officials told investors gathered during the 2011 Puerto Rico Credit Conference that this year’s proposed budget includes a two-pronged initiative to improve the Retirement System’s liquidity by increasing employer contributions by 1 percent over the next five years, and segregating the system’s assets among the central government, municipalities and public corporations.

Other measures, such as increasing employee contributions, limiting the approval of personal loans through the system, and capping pensions are other measures under consideration to address the retirement fund’s issues, Government Development Bank President Juan Carlos Batlle said.

“This is not new. We anticipated this last August when we announced that Moody’s has assigned a negative perspective on our General Obligation bonds for the specific reason of the Retirement System’s financial situation,” Batlle said Tuesday. “They haven’t downgraded us yet, but they’re clearly warning us that they can do it in the next three months if we don’t take the right steps.”

Gloomy rationale
In its report, Moody’s explained that its warning responds to the underfunding of the Retirement System, which it said is not consistent with the current A3 rating. The conclusion of its 90-day review could result in a rating change of one or more notches.

“The A3 rating reflects the commonwealth’s weak economy, which has been in recession since 2006; the budgetary structural imbalance, brought on by years of overestimating revenues, underestimating expenses, and making up the difference with one-time revenues and deficit borrowing; the actions taken in the past two years to dramatically reduce that structural imbalance, largely through cost reduction; and the proactive steps the administration has taken to stabilize the economy and the finances of the island,” Moody’s said.

In its assessment, Moody’s further noted that Puerto Rico’s pension plan system is “far weaker financially” when compared to the provisions in place in the 50 states. The combined unfunded liability, $24 billion, and total net tax-supported debt, $42 billion, together represent roughly seven times the annual budget, a combined burden that will exert significant budgetary pressure for many years to come, the respected agency said.

“Based on the Governor’s recently announced plans, the commonwealth would be required to increase contributions into the plan, further straining the budget. While the majority of the unfunded pension liability is tied to a closed plan and therefore has a limit to its potential size, the magnitude of the unfunded liability still raises questions about affordability and sustainability,” Moody’s noted.

The central government is responsible for approximately 64 percent of total employer contributions to the retirement fund while public corporations and municipalities must put up the rest. The government’s required $1.5 billion contribution to the system represents 16 percent of its general fund budget.

Legislation pending to shore up capital
House Bill 3336 was filed in April proposing an amendment to the Infrastructure Financing Authority’s governing law to authorize transferring $162.5 million from its core account to the Retirement System.

Mayol explained the money would be used to buy a zero-coupon bond that at a 7 percent interest rate would yield $1.2 billion for the system upon maturity in 40 years.

“I hope the bill reaches the governor and he signs it into law before June 30 so that we can start fiscal 2012 with that available,” Mayol noted.

The bill has yet to move to the Senate for review.

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