Puerto Rico adopted a major pension reform Thursday night.

Government Development Bank for Puerto Rico president Javier Ferrer said the reform, along with the general fund appropriation, will eliminate the system’s cash-flow deficit.

“We’ve said that the time has come to act responsibly and to stop kicking the can down the road because the present and future pensions of our public employees are at stake,” Ferrer said. “Very few other jurisdictions have implemented a pension reform as extensive and comprehensive as this one, necessary due to the precarious situation of our system.”

The Employees Retirement System is the commonwealth’s largest government employee retirement system. It has only 6 cents for every dollar actuarially required. All three major rating agencies have said that the system as it has existed was a potentially large financial problem for the government.

If nothing had been done, the fund was expected to run out of money in 2019. The government would have been forced to make large payments from its general fund to support the pensions.

The enacted reform will also require general fund contributions to the pension fund, but they will be steady and moderate in size.

After negotiations to reconcile earlier measures out of each house, the Senate Thursday approved the reform to the Employees Retirement System by 14 to 11. The House of Representatives followed suit with a 26-to-22 vote. Shortly thereafter, Gov. Alejandro García Padilla signed the bill.

“Just as we worked on this project, I’m sure that we will continue to work hard, day and night, to stabilize and eventually restore government finances and stimulate Puerto Rico’s economy,” Treasury Secretary Melba Acosta Febo said. “We have a long way to go, but we are hopeful that we will soon begin to see the fruits of those efforts.”

Muni industry observers cautiously embraced the pension reform.

Standard & Poor’s said the reform was a credit positive for Puerto Rico. It “could significantly reduce a source of budgetary and cash-flow pressure for the central government and its agencies,” credit analyst David Hitchcock wrote. Nevertheless, how the government handles its $2.1 billion structural general-fund deficit will be more important in determining S&P’s rating, currently BBB-minus for Puerto Rico general obligation bonds.

Janney Capital Markets managing director of fixed-income research Alan Schankel agreed with Hitchcock.

“The final pension plan was less impressive than original proposals with, for example, retirement age threshold limits watered down, but it is still a significant step,” he said.

“I think it is clearly good news” for the Puerto Rico government’s finances, said Karen Krop, a senior director for Fitch Ratings. “It is one of the things they needed to do…. The action itself is assumed in our rating.”

Puerto Rico’s GO debt is rated BBB-minus by Fitch and Baa3 by Moody’s.

Municipal Market Advisors managing director Robert Donahue was a bit skeptical.

“The pension reform is undeniably a good step that should slow Puerto Rico’s recent barrage of negative headlines,” he wrote. “Below the surface, however, results are far from clear.... On a net-asset basis, it still leaves the commonwealth with many years of zero percent or negative funded status and a large actuarial liability.”

While the reform will probably reduce the burden on the government’s general fund over the long term, the reforms will require a $200 million annual appropriation from the general fund, according to Donohue.

Additionally, the change in the pension may prompt 15,000 employees to retire before the new system goes into place, he said. Normally, only about 250 retire each month. The wave of retirements will require the government to pay for unused sick and vacation leave, Donahue noted.

On the other hand, once many people leave, the government may save money by not filling the positions, he said.

Reducing payments to retirees may ultimately lead to them spending less money, undermining an already weak economy, he wrote.

The government unions have already said they will challenge the pension reform in court.

The opposition New Progressive Party has pledged to reverse the pension reform if they won the elections, and it remains to be seen if they would follow through if elected in 2016, Donahue wrote.

The existing pension plan is actually three plans, with enrollment based on when employees started employment with the government. Two earlier plans have had defined benefits. Employees covered by those would be converted to hybrid plans, with defined benefit and defined contribution components.

Employees who started working more recently are covered by System 2000, a defined contribution plan.

Retiring employees of all three plans will be given annuities rather than single lump-sum payments, as had previously been the case. Retiree benefit amounts will be grandfathered.

The retirement age will be increased for most employees, and particularly for new employees joining the government after July 1. Legislative changes to the original proposal lowered some of the retirement ages. Employee contributions will be hiked to 10% from 8.275%.

Finally, the reform will eliminate or reduce a number of bonuses. Legislative changes to García Padilla’s original proposal watered down the cuts.

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