Pension issues may hurt state ratings: Moody's

WASHINGTON Thu Jan 27, 2011 5:08pm EST

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WASHINGTON (Reuters) - Some U.S. states face so much pressure to fund pensions for public employees that it could hurt their credit ratings, Moody's Investors Service said on Thursday.

As concerns grow over the financial health of many states after the 2007-2009 recession and how they will cut spending to cope, the ratings agency combined pension and debt data to rank the liabilities of each state.

In the past, Moody's evaluated credit risks from pensions and debt levels separately. Lower credit ratings could raise the costs to states of borrowing money.

Connecticut, Hawaii, Illinois, Kentucky, Massachusetts, Mississippi, New Jersey and Rhode Island, along with Puerto Rico, have the largest debt-and-pension loads, Moody's found.

Nebraska and South Dakota have the lowest.

"Large and growing debt and pension burdens have been, and will continue to be, contributing factors in rating changes," Moody's said.

Problems with pensions -- which states have underfunded by at least $700 billion -- include weak returns on investments, not enough money set aside, impending retirements of "Baby Boomers" born in the late 1940s through mid-1960s, and Americans living longer, Moody's said.

New York, Delaware and California are often cited for large debt burdens but do not have the highest combined long-term liabilities, Moody's analyst Ted Hampton said in a statement.

"In general, states' rankings for debt and pension combined parallel their rankings for debt alone," Hampton said but he added: "not all states with large debt burdens also suffer from weak pension funding."

IN THE TRILLIONS?

The $700 billion underfunded figure is a conservative estimate for how much money states will need to cover the pension promises they have made to their employees.

But $3 trillion could be nearer the mark, one study warned last year. States expect too generous a return on investments made by their pension funds, said the study by Joshua Rauh of the Kellogg School of Management at Northwestern University.

Regardless of the exact amount, states have to find a way to adequately fund pensions.

"More and more, it's going to take up a larger share of their ... budgets," said Kil Huh, director of research at Pew Center on the States, which has been closely following the pension issue.

Money flows from three major sources into pension funds: employee contributions, the employing governments and investment returns.

"Employee contributions have gone down and, at the same time, employer contributions because of the fiscal crisis haven't been there," Huh said.

Moody's, too, says the problem is getting bigger.

"Unfunded pension liabilities have grown more rapidly in recent years because of weaker-than-expected investment results, previous benefit enhancements and, in some states, failure to pay the full annual required contribution," the report said.

"Moreover, pension liabilities may be understated because of current governmental accounting standards," it added.

The Moody's report "will shed more light upon the states which have eliminated or underfunded their yearly contributions for pension liabilities simply as a way to manage their finances," said Thomson Reuters Senior Market Strategist Daniel Berger.

One dramatic solution to the pension problem would be allowing states to declare bankruptcy, which some congressional Republicans want. Then, they could renege on pension promises made to employees.

After being criticized for missing risks in the housing boom, Moody's is showing with this report it's "not asleep at the wheel" on the pension threat, said Richard Larkin, senior vice president and director of credit analysis at Herbert J Sims & Co. in New York.

But, the report also showed the liabilities are manageable, he added. For example, Moody's found Hawaii's pension-and-debt load is equal to 16.2 percent of its gross domestic product, the biggest proportion of all the states.

Even though the liabilities are in the billions of dollars, "when you compare them to GDP it's still low numbers," Larkin said.

"And it's still relatively much lower than these problem countries people keep comparing them to," he said, referring to recent fears that California or Illinois will soon be plunged into troubles similar to those Greece or Ireland are facing.

(Additional reporting by Karen Pierog in Chicago; Editing by John O'Callaghan and Philip Barbara)

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