Illinois pension debt to double as new Moody’s methodology kicks in

It’s taken as fact that Illinois’ five state-run pension systems have a $100 billion funding shortfall. That’s what the official reports say. But all that’s about to change. Moody’s Investors Service is making good on its promise to evaluate state pension plans on more realistic assumptions. The rating agency has long critiqued the pension funds’...

It’s taken as fact that Illinois’ five state-run pension systems have a $100 billion funding shortfall. That’s what the official reports say.

But all that’s about to change.

Moody’s Investors Service is making good on its promise to evaluate state pension plans on more realistic assumptions. The rating agency has long critiqued the pension funds’ use of overly ambitious investment return targets that allow the funds to understate their true pension shortfalls.

That means Illinois’ total pension shortfall is set to double when Moody’s evaluates Illinois’ pension funds based on investment return targets that more properly reflect today’s market realities.

And what Moody’s says matters. Its evaluation of the state’s ability to repay its debt means a lot to the investors who lend billions to Illinois state government.

Moody’s has already downgraded Illinois five times in the past four years, and it rates the state’s credit the worst in the nation. Fitch Ratings and Standard & Poor’s Ratings Services, the other two major rating agencies, have also downgraded Illinois a combined total of eight times in that same period.

The state’s credit is just four notches away from reaching junk bond status. Any further downgrades mean the state is likely to face problems borrowing money.

New methodology ups Illinois 2011 pension debt by more than 60 percent

Moody’s new methodology was already at work when it downgraded Illinois debt to A3 from A2 on June 6, 2013. The rating agency cited that it had evaluated the state’s 2011 pension data and that its adjustments included “…a market-based discount rate to value the liabilities, rather than the long-term investment return used in reported figures.”

In 2011, Illinois’ state pension systems used an average expected return of more than 8 percent to value their funds, resulting in a funding shortfall of $83 billion.

Moody’s, however, used a much lower 5.67 percent, reflecting the market rates existing at the time of the funds’ 2011 valuation. As a result, the state’s net pension liability jumped to 238 percent of state revenues. That puts the unfunded liability of the state’s five pension systems at nearly $135 billion, more than a 60 percent increase.

That unfunded liability will jump even more when Moody’s reviews the state’s 2012 pension data. The interest rate used to evaluate the liabilities will be much lower, at 4.1 percent, according to the agency’s new methodology. At that rate, the unfunded liability will approach $200 billion, a figure similar to the $209 billion the Illinois Policy Institute calculated late last year using preliminary proposals from Moody’s.

The size of the shortfall matters

Moody’s has warned in its most recent downgrade report that Illinois faces a “severe pension funding shortfall.” And surely, a $200 billion shortfall means even bigger trouble for the state.

Unfortunately, the pension bills being considered by Gov. Pat Quinn and the General Assembly do nothing to address the true size of the problem or the root cause of the pension crisis – the failed defined benefit plans.

In fact, House Speaker Mike Madigan’s and Senate President John Cullerton’s plans make things worse by introducing a pension-funding guarantee to prop up the failed defined benefit model. And that just means more taxes.

The only plan that that meets the state’s challenge is the one proposed by state Reps. Tom Morrison, R-Palatine, and Jeanne Ives, R-Wheaton, House Bill 3303, which is based the Institute’s pension reform plan.

State Sen. Jim Oberweis, R-Sugar Grove, introduced a floor amendment to Senate Bill 2026, which is identical to House Bill 3303.

That solution follows the lead of other states and the private sector by adopting defined contribution plans going forward. It’s the only proposal that ultimately solves Illinois’ pension crisis.

The Moody’s report highlights the need for a solution that is proportional to the size of Illinois’ crisis.

The Institute has designed a plan that does just that.