NEW YORK–(BUSINESS WIRE)– Yesterday’s approval of broad pension reform by the Rhode Island legislature increases financial stability for the state and may set a precedent for other U.S. states, according to Fitch Ratings.
Rhode Island’s pension reform provides some relief to the state’s municipalities to the extent that they participate in the state’s pension plans. The governor is expected to sign the legislation within the week. The reform is unusually expansive. Specifically, it changes the benefits available to currently vested employees as well as current retirees going forward. The sweeping nature of the reform may inspire similar efforts in other states grappling with large unfunded pension obligations. Fitch will closely monitor the nature and progress of expected legal challenges to the legislation, for their implications both in the state and nationwide.
The Rhode Island Retirement Security Act of 2011 was introduced by Governor Chafee and General Treasurer Raimondo. The Act tackles a wide range of factors that determine the liabilities of the state’s pension systems. Among them are retirement age, cost of living increases, amortization period of the unfunded accrued liability, employee and employer contributions, level of future benefits, and plan design. In addressing all of these factors in one piece of legislation, and applying the reforms to current, future, and retired state employees, teachers, judges, public safety personnel, and municipal employees (six pension systems in total), Fitch believes Rhode Island’s pension reform is the most comprehensive measure undertaken by any of the states in recent years.
Fitch views as an important credit factor the Act’s expected reduction of the systems’ unfunded actuarially accrued liability to $4.3 billion from $7.3 billion; a $3 billion or 41% reduction. Further, the Act will provide significant annual cost savings and provide employers with a degree of protection from market volatility due to the systems’ move to a hybrid defined benefit/defined contribution plan. To ease the rate of growth in required contributions, the Act also changes to a 25-year amortization period for the unfunded accrued liability from the prior 19 years.
The Act will take effect in the fiscal year beginning July 1, 2012. Based on the June 30, 2010 actuarial data that will be the basis for contributions in that year, the state’s actuary anticipates that the reform provisions improve the funded ratio for the state employees’ pension system defined benefit plan from 48.4% to 59.8%; the teachers funded ratio is expected to improve from 48.4% to 61.8%. The plans are expected to exceed 80% funded in fiscal 2032 for state employees and fiscal 2030 for teachers, with full funding of the systems occurring in 2035 and minimum funding levels of 52.4% and 55.5%, respectively, with the June 30, 2013 valuation. These assumptions are based on a 7.5% assumed market return.
The state’s actuary estimates annual savings to the state in fiscal 2013 from reduced contributions to the state employees’ system at $95 million and $63 million for the state’s contribution to the teachers’ pension system. The annual savings, at 39% and 42% respectively compared to current pension provisions, equates to 5% of the state’s general revenue fund budget for fiscal 2012.
According to information provided by the state, combined contributions to state plans from local units will still increase, albeit modestly, from fiscal 2012 levels but will provide significant savings compared to baseline fiscal 2013 contributions. The magnitude of benefit to local governments will vary based on the proportion of total pension liabilities that relate to state as opposed to local plans. For those localities in which the majority of workers are in local plans, which the Act does not address, the budgetary impact from the Act may be modest.
Fitch rates the State of Rhode Island’s general obligation bonds ‘AA’ with a Stable Outlook. Recent rating actions have noted Fitch’s expectation of significant pension reform in the near-term.