New accounting rules that will force municipalities to report net pension liability could trigger credit downgrades in Pennsylvania, according to one pension expert.

"There are no funding requirements in connection with these changes. However, credit downgrades are a distinct possibility," said Richard Dreyfuss, an adjunct fellow at the Manhattan Institute's Center for State and Local Leadership. He added, however, that the Governmental Accounting Standards Board requirements could spur cities to adopt better funding policies. The independent GASB, which sets accounting and financial reporting standards for U.S. state and local governments, is requiring application of the new standards in fiscal years beginning after June 15, 2014.

Dreyfuss' comments followed a 14-page report on Wednesday from state Auditor General Eugene DePasquale that said 573 Keystone State municipalities are distressed and underfunded by at least $6.7 billion as of the Jan. 1, 2011, valuation date.

Philadelphia alone accounts for $4.8 billion, followed by Pittsburgh's $380 million.

"The presentation of the net pension liability will have a direct and immediate impact on the balance sheet of all municipalities. It might also have negative consequences when a municipality seeks loans or bond financing," DePasquale said in the report, which he revealed at a press conference with Pittsburgh Mayor Bill Peduto. Both Democrats took office in January.

DePasquale's office has no legal authority over the pension plans.

Of the 573 distressed plans, 444 are funded at 70% to 89% levels, 108 are between 50% and 69% and 24 are in "severe distress," below 50%.

Pension debt is already a political football at the state level. Dreyfuss estimated Pennsylvania's unfunded liability at $59 billion using the market value of assets. The state's inability to overhaul the benefit packages of its two state employee retirement system has triggered bond-rating downgrades.

Fitch Ratings and Standard & Poor's rate Pennsylvania's general obligation bonds AA, while Moody's Investors Service rates them Aa2.

Nationally, Detroit's bankruptcy plan, which proposes to cut police and firefighters pension payments by 10% and to cut all other city employees' pensions by up to 34%, cast a pall of uncertainty. Philadelphia consulting group Public Financial Management Inc. estimated state unfunded obligations at $833 billion.

"Detroit is not alone," DePasquale said.

DePasquale made 12 recommendations to address underfunding and what he called "systemic issues."

They included a ban on "spiking" overtime and lump-sum payments, narrowing the range of acceptable investment rate assumption, creating a distress recovery program and amending the state-aid distribution formula to reflect distress level, and limiting the commonwealth's pension-cost reimbursement capacity.

In addition, DePasquale called for consolidating local government pension plans into a statewide system plan segregated by different employment classes, such as police officers, firefighters and non-uniformed employees, for current and future municipal workers.

"It is naïve to view this [problem] as simply one of underfunding," said Dreyfuss, an actuary and business consultant who worked for Hershey Co. for 21 years. "The systemic issues involve the toxic combination of [traditional] defined-benefit plans and politics. The auditor general's recommendations, by not even mentioning [401(k)-style plans], reflect his defined-benefit bias. As such he is defending the institutional defined-benefit plans."

DePaquale's suggestions, according to Dreyfuss, raise several other questions.

"Who enforces state pension laws? Why not use the best demonstrated practices in the Pennsylvania private sector? Why not just get out of this business rather than building up more government oversight?"

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.