Bond Downgrade Will Cost Vermont

On Oct. 23, Moody’s Investors Service announced that it was downgrading Vermont’s general obligation bond rating from Aaa to Aa1, citing demographic concerns along with the state’s unfunded pension obligations.

According to Moody’s: “The downgrade of the ratings incorporates an economic base that faces low growth prospects from an aging population. At the same time, the state’s leverage, measured by debt and unfunded post-employment obligations relative to GDP, is high among states and especially among the highest rated states.”

It is imperative for Vermont policymakers to heed Moody’s advice and shore up the state’s pension systems. The rating downgrade will hamper Vermont’s ability to borrow money and it will raise the interest rate the state will face when doing so, increasing the costs to taxpayers for public works projects and other activities financed by government. Beyond just the downgrade implications, pension debt payments increasingly crowd out other essential state services, including K-12 education and public safety.

Those unfunded pension obligations include $1.5 billion in the Vermont State Teachers’ Retirement System and another $780 million in the State Employees’ Retirement System. That translates to pension plans that are 55 percent and 71 percent funded, respectively, at the end of the most recent fiscal year. This means the plans’ assets are well below the amount they believe they will need to pay the benefits they’ve already promised to the state’s workers.

The low funded ratios facing Vermont are in large part due to structural weaknesses in funding policies, that were brought to light by the 2008 financial crisis and continue to hold the plans back in their recovery. The teachers’ system was 85 percent funded in 2007 and just 65 percent funded in 2009. For the state employees’ system, the funded ratio fell from 100 percent funded in 2007 to 79 percent funded in just two years. In the years since, inadequate funding policies and unmet assumptions have continued a gradual decline in solvency for both plans. The markets may have recovered but Vermont funded ratios have not, and what’s more, the risk of another financial crisis remains unaddressed.

In addition to Vermont’s unfunded pension benefits, according to a recent Truth in Accounting report, the state has accumulated $3.2 billion in bond debt and $3 billion in unfunded retiree health care benefits. This total debt of $8.3 billion, given the state’s $3.7 billion in assets, amounts to more than $20,000 for each Vermont taxpayer. This bond debt and failure to properly pre-fund benefits already earned by public employees led directly to Moody’s decision.

Vermont’s demographics and political system provide further reasons for concern. The latest Census population estimates suggest that Vermont’s population is now lower than it was in 2010. Bureau of Labor Statistics data show the number of people employed in Vermont remains below its 2006 peak. This means fewer taxpayers available to shoulder pension debt burdens.

Vermont is unique among the 50 states in not legally requiring a balanced operating budget. Although the state does not generally exercise this prerogative, the fact that it can legally run deficits is not good from a creditor’s perspective.

The situation in Vermont contrasts sharply with a recent credit upgrade in Michigan and an improved outlook for Colorado after both implemented pension reforms that combined meaningful funding policy changes designed to pay down accrued pension debt faster with modest changes to benefits for new hires. These reforms continue to provide retirement security while lowering the risk of similar debt problems arising in the future.

A similar effort in Vermont that acknowledges risks, stabilizes costs, and reverses the growth in unfunded liabilities could support a return to a Aaa rating. Such an effort is needed to ensure reliable post-employment benefits for the state’s retirees.

This column first appeared in the Vermont Digger.