Fitch Downgrades Illinois over Pensions Mess

(June 4, 2013) — Not content with having one of the worst public pension systems in the US, Illinois has the lowest credit rating-and it just got worse.

Last night, ratings agency Fitch downgraded the state of Illinois from “A” to a “A-“, with a negative outlook, following the last-minute debacle to try and solve its estimated $187 billion pension hole.

The state already languished in at the bottom of the US states in terms of its credit worthiness – yesterday’s announcement just secured its unfavourable position.

“FAILURE TO TAKE ACTION ON PENSIONS: The downgrade reflects the on-going inability of the state to address its large and growing unfunded pension liability, most recently through the failure to pass pension reform during the regular legislative session that ended May 31, 2013,” the agency said in its report.

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“Fitch believes that the burden of large unfunded pension liabilities and growing annual pension expenses is unsustainable, and that failure to achieve reform measures despite the substantial focus on this topic exacerbates concern about management’s willingness and ability to address the state’s numerous fiscal challenges.”

Specifically, the agency criticised the latest attempts by politicians to sort out the mess by tabling competing bids to solve the problem.

“INABILITY TO REACH AGREEMENT ON PENSION REFORM: The legislature grappled with various pension reform proposals throughout the most recent legislative session and, despite competing legislation passing in both the house and senate, was not able to come to agreement on a final form of pension reform…. In evaluating the credit impact of any reform, Fitch’s focus would be whether the changes enhance the funding levels of the pension systems and control the impact of pension payments on the budget.”

Fitch said although temporary corporate and personal tax hikes would help in the short term the outlook for the state’s finances needed to be sorted out quickly.

“Long-term solutions remained elusive,” the agency said, citing not just pension problems, but “also to maintaining budgetary balance in light of the temporary nature of the tax increases and the large accounts payable backlog.”

A lower credit rating is likely to push up borrowing costs for the cash-strapped state.

Already the agency said it had downgraded debt that was supported by the state and funded a multi-million dollar sports centre.

Earlier this year, Illinois settled with the Securities and Exchange Commission over claims the state had not fully informed investors about true nature of its pension liabilities.

Fellow ratings agency Moody’s told states in March that they would be examining their pension liabilities increasingly closely when making a judgement on their credit-worthiness.

This may not be the last we hear about Illinois on the matter.

A fall in the three-month average in interest rates has resulted in higher liabilities for Dutch schemes, putting them in the firing line of the regulator.

(June 4, 2013) – Smoothing strikes again: The average coverage ratio of Dutch pension funds at the end of May was 104%, despite market rates increasing last month, according to consultant Aon Hewitt.

The coverage ratio drop has been caused by a surge in liabilities, driven by a lower average interest rate over a three-month period and the Dutch smoothing mechanism.

In order to discount liabilities, Dutch pension funds are made to use the three-month average of the interest-rate curve. However, assets are calculated using mark-to-market valuations.

Interest rates rose in May, which would normally be a good thing. However, the three-month average no longer includes February, which had a higher rate than March, April and May.

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This means the new three-month average uses lower rates to calculate what the Dutch call their Ultimate Forward Rate, resulting in an increase in liabilities and a worse coverage ratio.

If the May market rate alone had been used to calculate the UFR instead, the value of the liabilities would have actually declined (and therefore the coverage ratio would have increased), but the forced use of a three-month average actually saw it increase (and the coverage ratio decrease).

The fall in average interest rate resulted in an increase in the value of the liabilities, of approximately 1.5%.

The 104% reported by Aon Hewitt’s Pensioenthermometer is worrying as by law, Dutch pension funds are required to have a minimum coverage ratio of 105%.

The rise in market interest rates in May also resulted in a drop in the value of the fixed income portfolio of 3.5%, although this was partly offset by good results in the US and European exchanges.

ABP, Europe’s largest pure-play pension, admitted earlier this week that despite an investment return of 13.7% in 2012, its overall funding ratio only improved from 94% to 97%, because of liabilities increasing by 10.7% and persistently low interest rates.

The pension giant was one of several big-name Dutch funds forced to reduce the payments made to pensioners in order to shore up its balance sheet this year.

ABP Chairman Hennk Brouer warned further pensioner payment cuts may be necessary if conditions don’t improve.

For an up-close-and-personal look at what is happening in the Dutch pensions sector, read about aiCIO‘s recent visit in the next edition, which is published later this month.