Illinois, which has the worst-funded state pension system in the United States, agreed on Monday to settle federal civil securities fraud charges alleging it repeatedly misled municipal bond investors about the underfunding of its pensions, according to the Securities and Exchange Commission.The municipal bond market is a very dangerous place to be. In addition, to the likelihood of interest rates climbing, the true financial picture of many state and local governments are unclear. Illinois is far from the only state with serious financial problems.
The settlement of charges that Illinois failed from 2005 to early 2009 to fully tell investors the risks of buying $2.2 billion worth of its municipal bonds is the latest blow to the state's reputation as fiscally troubled and crippled by a pension shortfall of $98.6 billion.
In official statements accompanying bond offerings Illinois explained that factors such as market performance had contributed to the increase in its unfunded pension liability, but it "misleadingly omitted to disclose the primary driver of the increase - the insufficient contributions," the SEC said.
In order to keep its contributions low, Illinois had developed a complicated system that included "ramp-ups" and "pension holidays," the SEC said.
Instead of paying to pension funds what actuaries had determined to be the annual contributions, Illinois followed a funding plan approved by the legislature that deferred the payment of pension obligations, compounding its pension burden.
The legislature phased in the state's contribution over a fifteen-year "ramp" period, where the amount Illinois put in gradually grew until in 2011 it made the full amount. It then had to put in a level amount so the pension system was funded by 2045.
The state went further, amortizing pension costs over 50 years, instead of the typical 30, which gave it a longer window to pay off the liability. Then, it lowered the contributions in 2006 by 56 percent and in 2007 by 45 percent in "pension holidays."
Illinois "failed to disclose the effect of its unfunded pension systems on the state's ability to manage other obligations, the SEC said. "The state also did not inform investors that rising pension costs could continue to affect its ability to satisfy its commitments in the future."
It also did not explain to investors that its "inability to make its contributions increased the investment risk to bondholders," the SEC said, adding it "did not identify or discuss how this underfunding compromised the state's creditworthiness or increased its financing costs."
The state of Illinois has $19.67 billion pension obligation bonds outstanding, out of a total of about $50.2 billion in outstanding municipal bonds, according to Thomson Reuters data.
Tuesday, March 12, 2013