UPDATE 1-Illinois pension reform inaction a negative-Moody's

Thu Aug 23, 2012 5:58pm EDT

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Aug 23 (Reuters) - Illinois' failure to improve its sagging public retirement system during a special legislative session last week is a negative credit factor for the state, Moody's Investors Service said.

"Inaction on the state's pension liabilities will further strain this lowest-rated U.S. state's finances," the credit rating agency said in a report on Thursday.

Illinois has an A2 general obligation rating, the lowest among states Moody's rates. Before last Friday's special session, Governor Pat Quinn warned that the state's credit ratings could slide further if action was not taken to lower the $83 billion unfunded pension liability.

However, the one-day session produced no solution for the worst-funded state pension system in the United States amid political squabbling and labor protests.

"There are six legislative session days in late November and early December, but Illinois may not agree on an approach to pension funding until early 2013," Moody's said in the report. "In the meantime, the funding challenge will keep growing."

Citing the report, Illinois Treasurer Dan Rutherford said the state could be headed for another rating downgrade that will increase its borrowing costs. Moody's cut Illinois' rating in January and Standard & Poor's Ratings Services has warned of a multiple-notch downgrade if the state makes no progress this year on its pension liability and structural budget imbalance.

Pension costs have consumed revenue from 2011's big hike in income tax rates, according to Rutherford.

"Illinois' available resources can neither pay off its massive debt nor cover the cost of providing needed state services to all of its citizens," he said in a statement. "Comprehensive, constitutional, and fair pension reforms are required to reverse this situation."

Meanwhile, Moody's said legislation passed by Michigan lawmakers last week for the state's Public School Employees' Retirement System is a positive credit factor for school districts.

"The reforms will reduce (districts') pension-related budgetary expenses by capping the contribution rate at the fiscal 2012 level, thus shifting subsequent pension contributions to the state," Moody's said.

It added that increased employee contributions for pensions and retiree health care will reduce the system's unfunded liability "to some degree."

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