Escalating unfunded pension liability and bond-rating backlash will lurk as Pennsylvania's House of Representatives is set to reconvene at 1 p.m. Monday.

Nearly two weeks ago, Moody's Investors Service cited pension liability, among other factors, when it downgraded the state's general obligation rating to Aa3 from Aa2, affecting $11.1 billion of debt. Other rating agency action could follow, say capital markets insiders.

Pennsylvania is staring at an estimated $50 billion of pension liability — nearly twice the state's annual budget. Gov. Tom Corbett said that amount could spike to $65 billion within three years if unchecked.

Given the brevity of the House session in an election year, lawmakers could remain gridlocked over pensions.

The House and Senate will begin their regular fall sessions on Sept. 15.

"It's very unlikely they'll do anything meaningful on this issue," said Richard Dreyfuss, a Hummelstown, Pa., actuary and an adjunct fellow at the Manhattan Institute for Policy Research.

Before the House are two pension overhaul plans. Rep. Mike Tobash, R-Pottsville, has proposed a so-called hybrid plan that Corbett supports and which stalled on the House floor during the regular session that ended in early July. It would merge defined-benefit and defined-contribution plans for state and school employees.

Rep. Glen Grell, R-Hampden Township, has a threefold proposal that includes a cash balance plan, the issuance of pension obligation bonds and voluntary givebacks from public employee unions.

Dreyfuss, also a senior fellow at the Hershey-based Commonwealth Institute, said funding level, not design, is the problem. "It's hard to be arguing plan-design change while it's profoundly evident that we need a funding solution, not a plan design solution," he said.

Corbett, who is battling low polls in his re-election bid against Democratic businessman and former state revenue secretary Tom Wolf of York, has been pitching pension change statewide, linking the issue to property tax relief.

This year, he said, 163 Pennsylvania school districts filed for an exception to the limit on tax increases, all citing escalating pension costs. Last year, he said, 169 districts did likewise and pensions now consume 63 cents of every new tax dollar raised.

"Gov. Corbett would like to see school districts not raise taxes due to the pension issues the commonwealth faces. This would be a difficult task for any governor as school districts are rooted in contractual agreements with not much movement by the teachers' unions for givebacks," said David Fiorenza, a Villanova School of Business professor and a former chief financial officer of Radnor Township, Pa.

"I suspect candidate Tom Wolf or any other candidate will buckle under such pressure and not address the looming pension issues which threaten Pennsylvania's bond rating and future debt issues."

Corbett in early July signed Pennsylvania's $29.1 billion budget while deleting $72.5 million in line-item vetoes from the General Assembly's plan. Many of the cuts affected the legislature's budget for relocating offices in the aftermath of redistricting. Corbett noted that the plan still increased the General Assembly's budget by $320 million.

Moody's cited investment losses and a history of low statutory pension levels for the downgrade. Pennsylvania has been shortchanging its actuarially required contribution, or ARC, since 2005. Its two major state employee pension plans are the State Employees' Retirement System and the Public School Employees' Retirement System.

The downgrade affected $11.1 billion of GO debt and $2 billion of appropriation-backed bonds, as well as the programmatic ratings assigned to the state's intercept programs for distressed school districts.

Moody's is not alone. Standard & Poor's warned in April it could lower Pennsylvania from AA if pension overhaul remains stalled. Fitch in 2013 downgraded the state to AA from AA-plus, citing inactivity on pensions.

According to Moody's, "material reduction" in long-term liabilities, including pensions, could push Pennsylvania's rating back up. Additional deferral of pension costs and worse-than-expected revenue performance, among other variables, could lead to further downgrades, Moody's added.

Standard & Poor's in April warned of a downgrade, saying it was ready to "lower [Pennsylvania's] rating in the next few months," calling on state officials to pass "meaningful pension reform."

Nationally, pension funding remains a white-hot issue in public finance.

Pew Charitable Trusts said the gap between what state and local governments have promised in pension benefits to their workers and the funding to meet those obligations continues to widen. According to Pew, new data for fiscal 2012 show that state-run retirement systems had a $915 billion shortfall. When promises by local governments were factored in, the total pension debt exceeded $1 trillion.

"Perhaps the rating agencies hold the keys to any crisis; at some point, underfunded plans and a lack of mitigation may prompt a rating agency downgrade which in turn precipitates sales of the state's bonds and a decline in confidence that can only be solved through some reworking of debt, expenses and revenues," Michael Cembalest of JPMorgan Asset Management wrote in a report.

Dreyfuss, who oversaw benefit packages during his 21 years as a Hershey Foods executive, said the private sector would be a more effective yardstick.

"I wish there were more benchmarking to the private sector as opposed to other states … Kentucky does this, West Virginia might do that or Nebraska does that. It's more relevant to compare with the private sector of the state in question, in this case, Pennsylvania."

Natalie Cohen, director of municipal research for Wells Fargo Securities LLC, expects the gridlock to continue during the summer session. "There's very little support for increased taxes and revenue, and it's a short summer," she said.

The state's sheer makeup also restricts revenue streams, according to Cohen. "Pennsylvania has the least mobility in terms of in-migration and out-migration. You don't have many of those hip centers with young people moving in, like Center City Philadelphia, Austin [Texas], or San Francisco," she said. "There's an aging population, and it's aging in place."

The House is also expected to continue debate on authorizing Philadelphia to increase its cigarette tax by $2 per pack to fund its teetering school district. State and school system officials say the measure could provide $83 million for a district that last year needed a $50 million loan from the city just to open its schools on time in September.

Senate amendments to that bill created a five-year sunset to the tax and authorized a hotel room tax in Butler County, north of Pittsburgh.

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.