Orange County has an enviable credit rating but faces financial challenges in the long term with higher retirement benefits that kicked in this year, according to Amy Doppelt, managing director of public finance for Fitch Ratings, the New York-based debt rating company. The county recently refinanced hundreds of millions of dollars in debt related to the 1994 bankruptcy by issuing new bonds that will permit it to retire the debt a decade early and save more than $100 million. But it could face layoffs, cuts in services and other belt-tightening to balance the county budget as it tries to deal with an estimated $2.3 billion in unfunded pension liabilities. Doppelt said she has her eyes on the 2008 fiscal year, when most current labor pacts in the county expire. Another issue for the county could be a new accounting standard imposed by the Government Accounting Standards Board dealing with the identification and disclosure of the liability and funding status of post retirement benefits, other than pensions. These regulations, referred to as GASB 45, are expected to create a major accounting and funding headache for governmental employers. Doppelt recently talked with the Business Journal’s Pat Maio.
What is your take on Orange County’s ability to deal with unfunded pension liabilities?
Orange County, like many governments in California, is catching its breath, having been through,in Orange County’s case,a severe financial crisis. Most other municipalities experienced financial strain during the recession, where state revenues were cut significantly. Since then, all parts of the state are in recovery, revenues are up and reserves are being filled. The outlook is generally good, with the exception of a couple of things looming on the horizon. One is the significant increase in unfunded pension liabilities, which are requiring an increase in annual contributions that municipalities need to make to fund their pension systems. On top of that we have other post-employment benefit accounting rules, which will become effective in a few years. For the most part, these rules are for healthcare, and will require difficult choices.
How significant are these rules?
It varies throughout the state. Most entities offer some type of healthcare benefits to their retirees. In some cases, they offer the retirees to participate in the existing healthcare insurance plan, but the retiree pays for it. In other cases, the municipality pays for it. In some cases, that benefit is offered for the life of the employee, and in other cases there is some age limit on it, generally around 70. Preliminary estimates are showing some entities with unfunded liabilities close to their annual budget level, or even twice their annual budget level. But the annual contribution, if entities choose not to fund it, will create a liability on their balance sheet. If they don’t fund it, we would consider that an imprudent management decision.
How might OC cope with its $2.3 billion in unfunded pension liabilities?
It’s up to the county to decide. As a rating agency, what we focus on is what all this means to the county’s financial integrity, and for its ability to pay investors. So for any increase in expenditures, for anybody or any entity, there are a variety of ways to address this. You can try to reduce the expenditure itself, which would require renegotiating with labor groups and retirees. You can cut your expenses elsewhere. Or you can raise revenues.
There is a hiring freeze in the county. Is this an effective way to deal with unfunded pension liabilities?
Yes, that certainly helps going forward. But the unfunded liability focuses significantly on people who are already in the system.
Is there wisdom in issuing bonds to pay down the liabilities?
Yes, entities are looking into that. It may be cost effective, depending on the interest rates the bonds were issued at. A number of California counties have issued pension bonds.
Any negative concerns?
Well, there are a couple of things. Over time, the unfunded pension liability,a soft liability,could be changed based on certain actuarial assumptions, to a potentially hard liability where money is owed to investors. And that’s really not changeable once it’s done. It becomes a firm number.
The other downside is if issued pension bonds bring the system, say, from 70% funded to 95% funded, and then you get some good performance in the stock market, then suddenly the system becomes overfunded, and it becomes very tempting to give additional benefits to employees. It takes a strong will on the part of the county to recognize that overfunding could be fleeting.
What are your concerns about OC’s refinancing of bankruptcy debt?
In general, refinancing was a good thing for the county, which has been very conservative in paying down bankruptcy-related debt to achieve cost savings. Our concern on the county’s rating, as expressed in our report, is the unfunded pension liability and the significant increases that it is likely to face going forward. But it is not enough of a concern yet for us to lower our rating or give them a negative outlook.
How would you compare OC’s level of unfunded pension liabilities versus other local governments?
Orange County is below average. Most of the funding ratios we see are in the 80% to 85% range, which is about average these days. In Orange County it’s about 70%. The issue for us is that, while there is a problem looming, the county still has time to react.
Do you see the county reacting?
We are waiting to see. They are just in the early phases of figuring out the best approach going forward.
