WASHINGTON — Maryland Gov. Martin O’Malley on Friday released a pension reform plan to halt the state’s declining pension funding level, which is the lowest among triple-A rated states and has become a concern for rating agencies and investors.
O’Malley warned that without pension changes, the state’s funding-to-liabilities ratio will drop to 59% in fiscal 2012, down from 63% at the end of fiscal 2010 and 95% 10 years ago. Maryland in 2009 had the lowest funding ratio among the eight states rated triple-A by the three major rating agencies, according to data from Loop Capital Markets’ annual report on state pensions in October.
O’Malley’s reform plan comes after 19 states rewrote their pension laws last year, according to data from the National Conference of State Legislatures.
State pension funds were hammered during the recession as investment returns plummeted and as some states used pension contribution money to balance their budgets.
Meanwhile, muni investors are increasingly wary of states’ unfunded pension liabilities.
A state funded ratio below 70% begins to draw concerns from bond investors, according to market participants.
O’Malley said his plan will bring Maryland’s funding level to 80% by fiscal 2023.
The pension legislation is poised to be introduced into the General Assembly Monday night, a spokesperson for O’Malley said.
For Maryland, the pension concerns were becoming too great to ignore. Moody’s Investors Service in December said Maryland’s inadequate pensionfunded ratio posed “a credit challenge for the state.”
The state’s Public Employees’ and Retirees’ Benefit Sustainability Commission, which was created to make pension reform recommendations, warned earlier this month that failure to act “may endanger the state’s AAA bond rating.”
O’Malley’s plan requires employees hired after June 30, 2011, to contribute 7% of their salary to the pension program with a 1.5% multiplier. Current employees can choose to receive their current benefits at a reduced multiplier or opt for a 7% contribution rate at a 1.5% multiplier.
A new employee’s early retirement age would be 60 years instead of 55 and the final benefit package would be calculated on the five highest years of pay, not the three highest years under the current plan.
O’Malley’s plan follows similar pension reforms recently passed in Utah and Georgia, both triple-A states. These states switched to defined contribution plans for new employees, said Kil Huh, director of research at the Pew Center on the States and one of the authors of the 2010 Pew pension report entitled “The Trillion Dollar Gap.”
Maryland’s pension system “merited serious concerns because their funding level had dropped below 80%,” Huh said. O’Malley’s reform plan “is a step in the right direction,” he said.
But O’Malley’s plan changes current employees’ benefits, too. Beginning in fiscal 2012, the plan calls on current employees and teachers to chose between two formulas comprised of a worker’s contribution rate and the multiplier. By switching to a higher contribution rate, employees can receive a higher multiplier at retirement.
Yet pension changes for current employees can face legal challenges. Minnesota, South Dakota, and Colorado are currently in that situation, according to the NCSL.
In 2009, 14 states shifted to a defined contribution or hybrid plan to reduce long-term liabilities, according to Loop.
Chris Mier, a municipal strategist at Loop, said he expects this trend to continue in 2011.
Funding ratios are “at the moment … a real focus of concern” for muni investors, Mier said.
He said Maryland’s 59% funding ratio, about two years into the economic recovery, “would be a concern.”
Still, Maryland can turn down the heat with a pension reform law.
“It’s not so much the [funding ratio] that is critical,” but rather that the state’s reform efforts “are moving in the right direction,” Mier said.
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Corrected January 27, 2011 at 10:14AM: The article incorrectly characterized Gov. Martin OMalleys pension reform plan. The governor has proposed reforms to Maryland's existing defined benefit plan.