Cautious Optimism About Puerto Rico Pension Reform Plan

Several municipal bond observers are cautiously optimistic about the Puerto Rico government’s proposed pension reform plan.

Government Development Bank of Puerto Rico President Javier Ferrer and Puerto Rico Treasury Secretary Melba Acosta unveiled the plan Wednesday. Later in the day Gov. Alejandro García Padilla endorsed the proposal.

Puerto Rico’s pension system is far more underfunded than those in any of the 50 states. The Employees Retirement System has only 6 cents for every dollar actuarially required, the GDB states. The Teachers Retirement System has just 20 cents for every dollar.

Without changes the former system was expected to run out of money in 2019 and the latter system was to run out in 2022. The government would have to use its already hard-pressed general fund to subsidize them if they ran out.

On Wednesday the government introduced a proposal to reform the Employees Retirement System. The government plans to introduce a reform proposal for the teacher’s plan within a week, said García Padilla spokeswoman Yanira Hernandez.

The former plan is actually three plans, with enrollment based on when employees started employment with the government. Two earlier plans have defined benefits. Employees covered by these would be converted to hybrid plans – with defined benefit and defined contribution components.

Employees who started employment more recently are covered by System 2000, a defined contribution plan. In the reform plan, when those employees retire they would be given an annuity rather than a single lump-sum payment.

The employment retirement age would also be gradually pushed back to 65 or 67 from 58 to 65 for most employees. For police officers and firefighters the retirement age would go to 58 from about 50.

Employee contributions are to increase to 10% from 8.275%.

Finally, the proposal eliminates or reduces a number of bonuses and requires greater employee contributions for medical plans.

According to the GDB, 80% of retirees of the Employee Retirement System receive pensions of under $18,000 a year.

Bob Donahue, managing director of Municipal Market Advisors, and Alan Schankel, managing director of fixed income research at Janney Montgomery Scott, said the proposal was serious and significant. 

Donahue said he was “cautiously optimistic,” about the pension proposal. He said it faced three hurdles. First, the rating agencies will have to accept it, and he believed they would. Second, the government employee unions will have to accept it. Finally, it will have to pass the two houses of the Puerto Rico legislature.

Passage in the Senate seems likely, Donahue said. It may have some problems in the House of Representatives, however, even though it is controlled by the governor’s party, he said.

The pension proposal should allow Puerto Rico to avoid a downgrade from the rating agencies in the near term, Donahue said. The territory’s general obligation debt is currently rated Baa3 by Moody’s Investors Service, BBB by Standard & Poor’s and BBB-plus by Fitch Ratings. All three agencies have negative outlooks on their ratings.

“We view this announcement very favorably because, as a major attempt to resolve a key problem, it shows the seriousness with which the new administration in Puerto Rico regards the fiscal challenges facing the Commonwealth,” wrote three Barclays analysts in a report about the pension proposal.

“We’ll only see the benefits from this gradually, over time,” Schankel said. “They’re in a deep hole.”

The pension reform includes the government kicking in $100 million each year, Schankel noted. The budget is already under a great deal of pressure. It had $8.7 billion in revenue in fiscal 2012.

The pension reform will allow the government to sell bonds to refinance its debt. The government has said it wants to do this before the summer.

While he was running for office García Padilla criticized pension reform proposals by his predecessor Luis Fortuño. The current proposal is quite similar to that earlier proposal, Donahue said. Thus, the pension reform may damage García Padilla’s credibility with the electorate, Donahue said.

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