Underfunded pensions will lead Pennsylvania to more bond downgrades, said Commonwealth Foundation senior fellow Richard Dreyfuss

WILKES-BARRE, Pa. - Bond rating agencies are poised to downgrade Pennsylvania again based on its unfunded pension liability even if plan design changes Gov. Tom Corbett recommended for new hires clear the state legislature, a pension expert said Wednesday.

"It's still clear to me that what the bond rating agencies look for is the ARC," or annual required contribution, Commonwealth Foundation senior fellow Richard Dreyfuss said at a pension forum sponsored by the Pennsylvania Economy League research organization.

According to Standard & Poor's, Pennsylvania has not fully funded its ARC since 2004.

"I use the word 'required' humorously. The General Assembly adapted an ARC, then they didn't pay the ARC," said Dreyfuss, who oversaw compensation and benefits during his 21 years at Hershey Co. and is also an adjunct fellow at the Manhattan Institute for Policy Research.

Over the past two weeks, the three major rating companies warned of further downgrades should Pennsylvania fail to control its escalating unfunded pension liability, which Dreyfuss on Tuesday estimated at $73.7 billion.

Last year, Fitch downgraded Pennsylvania's general obligation bonds after the state made no changed to its pension plans. Fitch and S&P rate Pennsylvania AA, both with negative outlooks. Moody's rates Pennsylvania Aa2 with a stable outlook.

A proposal by Republican Corbett and state Rep. Mike Tobash, R- Schuylkill, would place new state and school employees into a hybrid plan that combines defined benefit, or traditional pension plans, with defined benefit, or 401(k)-style plans, among other changes. Nothing would change for current employees.

The state's major employee pension funds are the State Employees Retirement System and the Public School Employees Retirement System.

Dreyfuss advised against the use of pension bonds or other borrowing strategies to finance pension systems because they further leverage pension systems and create an incentive to improve benefits.

"People will tell you, 'we can borrow at 5% and get a 7-1/2% return,' but who said 7-1/2% is guaranteed?," said Dreyfuss. "Look at the inner workings of [bankrupt] Detroit and you'll see a pension obligation bond in all that mess."

He also advocated 15-year amortization periods and lowering return assumptions from 7.5% to between 6% and 7%.

Dreyfuss said states with healthier pension systems have made their ARC payments regularly. He cited Wisconsin, Wyoming, Utah, and North and South Dakota.

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