For the first time since 2007, Michigan will reap the benefit of a credit rating upgrade of its general obligation bonds. S&P Global ratings moved the state’s credit rating from AA-minus to AA, citing pension reform among the main reasons for the upgrade. This is a much-needed development that will allow the state to borrow funds at a lower interest rate and save taxpayers’ money.
Just over a year ago, Michigan enacted an innovative teacher pension reform, and the legislature is currently in the process of passing several follow-up reforms this year. The reforms are meant to address several factors that have threatened not only the state’s budget, but also the retirement security of the state’s public workers. [Note: the Pension Integrity Project at Reason Foundation provided technical assistance to various stakeholders during this process.]
In a nutshell, these reforms reduce risks, stabilize long-term costs, and improve pension funding policy, all while providing reasonable retirement plan options for new hires and ensuring the ability to responsibly pay down pension debt. Over time, this reform will lower the amount of unfunded liabilities and allow for a higher funded ratio of teachers’ pensions. Since such adjustments are making the state more likely to honor its debts, it makes sense that they would have a positive effect on the state’s credit ratings. Further, credit rating agencies assign “grades” to states in order to signal to the market the states’ overall economic situation and ability to pay debts. Since the pension reform reduced economic volatility, it improved chances of the state to get higher score.
It is far too early to analyze the full effect of Michigan’s pension reforms, but the credit rating upgrade is a good indicator that state policymakers are on the right track. This example shows that timely and sensible changes to a pension plan can have rapid positive effects on the fiscal outlook of a state, which in turn leads to bolstering state workers’ post-employment security and saving taxpayers’ money in the long-term. And although the full effects of the pension reform will be realized over the years, it is clear from S&P’s action that it has already contributed to improving the state’s economic prospects.