Puerto Rico is poised to adopt an overhaul of the teachers' pension system as the government defends the commonwealth's investment grade rating.

The Puerto Rico Senate on Monday night followed the House of Representatives in approving a reform plan that increases employee contributions and raises the retirement age for future teachers to 62 from 55. Gov. Alejandro García Padilla indicated Tuesday he would sign the bill.

"Reforming the commonwealth's teacher pension system is an important step forward in making the structural changes Puerto Rico needs to strengthen its long-term fiscal health," García Padilla said. "Teachers are integral in shaping our future and these policy changes reflect a compromise between teachers and my administration that will ensure that teachers can retire with confidence in the long-term economic viability of our pension system."

Puerto Rico bond yields have soared this year on the secondary market amid investor concern over the commonwealth's persistent budget deficits and weak economy. Moody's Investors Service this month put Puerto Rico on review for a downgrade, naming the reform of the teachers' pension system as one of five things that it would keep an eye on during the review period.

"This is Puerto Rico's early Christmas present to investors." Richard Larkin, senior credit analyst at Herbert J. Sims, said of the pension overhaul. Larkin also said he was looking forward to the Puerto Rican government approving the governor's proposal to keep its sales tax at 7% and to allow the municipalities to issue sales-tax backed bonds. Since the bonds would be based on the municipalities' collection of their 1.5% share, they would be a new senior lien sales tax bond for Puerto Rico, he said.

AllianceBernstein senior vice president Joe Rosenblum called the plan a "positive development, though we are still missing details on the impact on the general fund in the years beyond the next few. [It is] another sign of the government's commitment to right their fiscal/budgetary situation. And all within a time frame they told the municipal market. Still," he added, "we also need to see continued economic improvement to support their revenue structure."

Municipal Market Advisors managing director Robert Donahue said, "Puerto Rico's leaders are showing considerable courage to take steps to assuage the fears of investors.  They have responded to the rating agencies and investor community by demonstrating financial willingness, even at great political cost.  Apparently the teachers' unions are threatening to strike in early January.  Garc ía Padilla and [Puerto Rico Senate President Eduardo] Bhatia have worked together to push timely and much needed reforms and are to be commended."

Under the reform legislation, current employees will be switched into a hybrid defined benefit/defined contribution plan, with their future pension accruals going to the contribution side. Benefits from the latter will be paid out on retirement as a lifetime annuity.

Employee contributions will increase to 10% from 9% of earnings. Further increases may come in future years, pending actuarial certification.

The retirement age for employees hired in the future will shift to 62 from 55.

All teachers with at least 30 years of experience will get at least $1,625 per month upon retirement, a source close to the governor said.

The reform eliminates a "merit pension" of higher benefits for some retirees. It reduces special benefits for some retirees and eliminates them for future retirees.

The government also promises to increase its general fund contributions to the system by $30 million in fiscal year 2017 and by $60 million starting in fiscal 2019 through fiscal 2042. A supplemental annual contribution will also be provided starting in fiscal 2019.

Unlike other Puerto Rico government employees, Puerto Rico teachers do not pay into Social Security. Accordingly, they do not receive Social Security benefits based on their time as teachers.

The teachers' pension plan had a $10 billion actuarial liability and was expected to run out of money in 2020 unless it was overhauled. Without an overhaul, starting in 2020 Puerto Rico's general fund would have had to make large contributions to fund the deficit.

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