CHICAGO — In a move prompted by the Securities and Exchange Commission’s heightened scrutiny of pension-disclosure practices, Illinois unveiled overhauled reporting standards in its latest bond offering statement that also announced a rise in unfunded pension liabilities to $75.7 billion and revealed a pending SEC inquiry.

The state intends to sell $3.7 billion of eight-year taxable general obligation bonds in mid-February to fund much of the fiscal 2011 payments owed to its five public pension funds.

The sale was part of a fiscal bailout lawmakers approved earlier this month, which includes a temporary increase in state income taxes. The legislative action prompted Standard & Poor’s to remove the state’s A-plus GO rating from negative watch Tuesday.

In a preliminary offering statement published this week, the state divulges that it was contacted in September by the SEC about communications relating to the “financial effects” of pension reforms. Illinois last year established a two-tier system with reduced benefits for employees hired beginning this year. The SEC sought communications “relating to the potential savings or reductions in contributions” to the pension funds.

When Gov. Pat Quinn signed the legislation in April, he estimated the reforms would shave $100 billion of contributions needed to bring the state’s pension system to at least a 90% funded ratio by a deadline of 2045, under a 1995 funding plan.

The POS said the SEC informed Illinois that its inquiry should not be “interpreted as an indication by the SEC or its staff that any violations of federal securities laws has occurred.” The state reports it is cooperating and providing requested information.

The state anticipates that its statutory payments will begin to decrease in 2012 and continue to fall through 2045. At that time they will total $19 billion, instead of $25 billion had the reforms not been adopted, according to the offering statement.

The state reports in the offering statement that it decided to revamp its pension disclosure and reporting practices in August, after the SEC filed a lawsuit that month charging New Jersey with securities fraud. The commission charged the state with failing to disclose to bond investors that it was underfunding its two largest pension plans.

New Jersey agreed to settle the case without admitting or denying the SEC’s findings and said it would cease and desist from committing any further violations.

Illinois hired Chapman and Cutler LLP to assist in reviewing the enforcement action and to update its own disclosure policies and procedures using the New Jersey enforcement as a template. New Jersey’s disclosure woes were partly caused by a lack of communication between the state officials who handled its debt and those responsible for its pensions.

“After reviewing the New Jersey action, the state decided to be proactive and sought the advice of Chapman and Cutler and the attorney general’s office,” said state budget spokeswoman Kelly Kraft. “Not only do we feel we meet a higher standard set in the New Jersey case, but we believe we exceed it.”

Illinois has established a committee to oversee its pension disclosure process that is chaired by state debt manager John Sinsheimer. Disclosure items are submitted to the state comptroller, treasurer, and pension funds for review and comment.

More than 20 pages are devoted to pension fund reporting in the $3.7 billion offering statement, more than double the section in past offering statements, including the one for the state’s $3.5 billion sale of GOs to fund its fiscal 2010 pension payments early last year.

The section underscores just how troubled the Illinois pension system remains. The unfunded liability rose to $75.7 billion in fiscal 2010 from $62.4 billion in fiscal 2009. That lowered the state pension system’s funded ratio to 45.4% from a 51% funded ratio that is among the worst in the nation.

Illinois shifted to a five-year smoothing model in fiscal 2009 that limits the impact of near-term investment losses and gains. The unfunded liability would stand at $85.6, for a funded ratio of just 38.3%, based on the fair market valuation that recognizes gains and losses annually.

The unfunded actuarially accrued liability “increased between fiscal 2009 and the end of fiscal 2010 primarily as a result of insufficient state contributions as compared to the actuarially required contribution,” or ARC, the state wrote in the offering statement.

Illinois contributed $2.9 billion in 2009 while the ARC payment needed to put the state on track to fully fund its pension was $4.1 billion. The $4.1 billion 2010 payment fell short of the $4.8 billion ARC payment needed. The state has long failed to make payments that reach the ARC level.

The impact of the state’s $10 billion pension bond sale in 2003 has also fallen far short of expectation in raising the funded status of the pensions. The state pumped $7.3 billion of the bond proceeds into the funds to bring down the unfunded liability, using the remainder to cover near-term payments owed to the system.

Illinois in turn lowered its statutory contributions by the amount needed to cover debt service on the 2003 bonds. The state assumed investment returns would exceed debt service, driving down the unfunded actuarial accrued liability, or UAAL.

“In actuality, the significant investment losses experienced by the retirement systems in fiscal years 2008 and 2009, when combined with the reduction in the required annual statutory contribution by debt-service payments on the 2003 bonds, created an even greater increase in the UAAL in those years,” the offering statement reads.

Debt service on the 2003 bonds ramps up from $543 million in 2010 to $1.2 billion in 2033. Throughout the pension disclosure section, the state says it provides “no assurance” that future legislative action, investment trends, or other variables won’t negatively impact the pension funds status.

The funds used an investment return rate that ranged from 8 to 8.5%, but two have lowered that rate to 7 and 7.75%. Illinois operates five funds that collectively serve 737,000 beneficiaries. They include one fund each for teachers, state employees, judges, the General Assembly, and university employees.

Some issuers were moved to update pension disclosure after the SEC took legal action in 2006 against San Diego for failing to disclose major problems with its pension and retiree health care obligations. John McNally, president of the National Association of Bond Lawyers, said the combination of the New Jersey case and the SEC’s establishment of a muni and public pension enforcement unit has prompted “renewed attention” on the subject among issuers.

Sinsheimer and members of the deal’s finance team are meeting with investors overseas and in several U.S. cities ahead of the taxable sale. Goldman, Sachs & Co., Loop Capital Markets LLC, and Morgan Stanley are co-book-running senior managers. Peralta Garcia Solutions is adviser and Kutak Rock LLP is bond counsel. The state is selling eight-year GO bonds with no principal payments in the first two years.

“The state is sharing with investors the tremendous progress it’s made towards enhancing its fiscal position,” one member of the finance team said. A temporary income tax increase approved earlier this year is expected to raise between $6 billion and $7 billion annually, but analysts believe it solves only the state’s near-term fiscal crisis.

On Tuesday, Standard & Poor’s affirmed the state’s A-plus GO rating and removed it from negative CreditWatch, where it had been since March. The outlook is negative. The action “reflects our view of the state’s recently enacted legislation that provides for structural budget solutions,” said analyst Robin Prunty.

The state’s credit remains challenged by its weak pension funds, high debt burden, and the possibility of up to $8.75 billion of additional borrowing to pay down bills. Quinn is pushing the borrowing, but it requires bipartisan legislative support.

Moody’s Investors Service affirmed Illinois’ A1 rating on $31 billion of GO debt and negative outlook, but its analysts remain concerned about the state’s long-term challenges. Fitch Ratings affirmed the state’s A rating and revised its outlook to stable from negative.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.