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Reform in Rhode Island Could Start Trend

NOV 18, 2011 7:07pm ET
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Rhode Island’s passage of landmark pension overhaul legislation could clear a path for similar moves in other states that need it, municipal and bond market observers say.

While providing financial relief for Rhode Island, the changes “may set a precedent for other U.S. states,” Fitch Ratings senior director Marcy Block said Friday.

Gov. Lincoln Chafee late Friday signed the bill, which he and General Treasurer Gina Raimondo had championed. The House and Senate passed it the previous night. It creates a hybrid plan that merges conventional public defined-benefit pension plans with 401(k)-style plans. While some other states have implemented hybrid plans, Rhode Island’s would be the first to affect current employees, according to the Pew Center on the States.

It also includes a suspension of cost-of-living adjustment increases for retirees and raises the retirement age for employees not yet eligible for retirement.

“Fitch believes Rhode Island’s pension reform is the most comprehensive measure undertaken by any of the states in recent years,” Block said.

Fitch, which rates the state’s general obligation bonds AA with a stable outlook, said recent rating actions have noted its expectation of pension changes in the Ocean State. Standard & Poor’s also rates Rhode Island AA, while Moody’s Investors Service rates the GOs an equivalent Aa2.

Alan Schankel, a managing director at Janney Capital Markets in Philadelphia, said Rhode Island’s law could establish a roadmap for other states that need pension overhaul.

“It also provides political cover. People can say they did it in Rhode Island, which is not the most conservative of states,” he said.

Under the law, which will take effect July 1, Rhode Island expects to reduce its unfunded pension liability to $4.3 billion from $7.3 billion, a 41% reduction, and boost the funding level for its defined benefit plan to 59.8% from 48.4%. The plans are expected to exceed 80% funded in fiscal 2032 for state employees and fiscal 2030 for teachers.

The Pew Center considers 80% a suitable benchmark for pension funding. In a lengthy report in April, the Washington, D.C., think tank said at least 19 states have nothing saved and use annual revenues to pay for retiree health care costs on a pay-as-you-go basis. Rhode Island’s pension plan is only 58.7% funded, according to Bloomberg.

“The Pew report got everyone going,” Schankel said. The Rhode Island bill, he added, “will still face legal challenges, but it’s very positive for Rhode Island and for the bond market, too. It’s been a big priority since the Pew report.”

According to the Pew study, Illinois is in the worst shape, with a pension system that is only 51% funded. It has had to borrow billions of dollars to make payments, allowing lawmakers this year to make the state’s full fiscal 2012 contribution of nearly $4.5 billion.

Rhode Island’s public-sector unions may sue over the new law, saying that the state cannot break contracts. “Pension theft creates longer careers. Pay, vacation, and health care costs will rise dramatically,” the Service Employees International Union Local 580 said on its website.

After more than five hours of debate Thursday, the House approved the bill by a 57-to-15 vote. The Senate approved the House version 32 to 2.

“This is the type of issue that had to be tackled,” said Raimondo, a former venture capitalist who, like Chafee, took office in January. In May, she warned that the annual cost of the pension fund could spike to $1 billion by fiscal 2022, and that the retirement plan for state employees and teachers could run out of assets as early as 2019.

Richard Licht, the state’s director of administration, ran point on the bill for Chafee. “Pain has been inflicted on retirees, state workers and taxpayers, but this is a major step forward,” he said after the vote.

On Aug. 1, Central Falls, with a population of 19,000, filed for Chapter 9 bankruptcy protection, citing an $80 million unfunded pension liability.

Other municipalities and conduit issuers in the state have sustained downgrades in the aftermath of the filing.

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