* Moody’s press release…
When fiscal 2019 begins on July 1, the State of Illinois (Baa3 negative) faces a sharp jump in its budgetary fixed costs for debt service, retiree healthcare, and pension contributions, part of a trend that may intensify in future years, Moody’s Investors Service says in a new report. A failure to adopt mitigating strategies soon will greatly increase the state’s risk that these rising costs will become unaffordable without severe public services cuts.
Without any revenue increases or legislation to reduce the state’s retirement benefit burden, Illinois’ total fixed costs will reach or exceed 30% of state-source revenue next year, with pensions accounting for more than half of the costs. Debt service, reflecting the state’s issuance of $6 billion of bonds in November 2017 to help reduce a backlog of unpaid bills, is scheduled to increase by 17%.
“Given their magnitude and growth trajectory, the state’s unfunded pension liabilities will likely require more than a single response,” said Moody’s analysts Ted Hampton and Tom Aaron, co-authors of the report. Illinois could raise revenue, shift some of the funding responsibility to local governments and public universities, or seek to reduce benefits. All of these approaches face potential political or even legal impediments, but the risks of inaction are significant for the state’s credit quality.
“Under some scenarios, Illinois could eventually find the burden of paying for retirement benefits becomes extremely difficult to manage,” Hampton said. “Part of the problem is that state officials always face the temptation of making the ultimate reckoning worse by pushing costs to the future, and they’ve used that approach many times in the past.”
In 2017, Illinois managed to keep the impact of its fixed costs from exceeding 30% of own-source revenues – approximately triple the median level for US states — by increasing income tax rates to boost revenues and passing legislation requiring that recent actuarial assumption changes be phased in over five years.
However, the growth of Illinois’ projected pension funding requirements will outpace its organic growth of tax revenues and the state’s economy. Moody’s says it anticipates that the state’s economy will continue to lag national trends as in recent years.
Severely unfunded pension liabilities leave Illinois far more exposed to adverse events such as a recession. Illinois’ pension funding needs will remain elevated even under favorable circumstances, but if the coming years include a recession and stock market downturn, the state’s funding burden could quickly become unsustainable without painful corrective actions.
“Illinois does have some ability to keep pushing costs to future years, in view of its plans’ assets on hand, but a decision to reduce current pension contributions would cast doubt on the state’s long-term ability to afford both accumulated liabilities and current services,” Aaron says. “Easing funding in favor of fiscal relief could erode the state’s credit.”
It’s unclear if Moody’s is aware of the pension proposals in the new budget.
*** UPDATE *** I asked David Jacobson, Moody’s VP for communications, if the ratings firm was aware of the pension changes in the BIMP. His e-mailed response…
We are, but don’t comment on pending legislation. Should this become official we will analyze the credit implications.