WASHINGTON - Mayor Sharon Pratt Kelly warned yesterday that the District of Columbia's credit rating could be hurt unless both the federal and city governments agree to pay more to eliminate the district's $5 billion unfunded pension liability.

"The unfunded pension liability is a major concern of the financial markets," Kelly told a House subcommittee. "It has been a continuing source of focus by the ... markets, and as we approach the date when Congress could potentially separate itself from the obligation" there could be "an adverse impact" on the district's rating, she said.

The D.C. Retirement Reform Act of 1979, which transferred a $2.6 billion unfunded liability from the federal government to the district, calls for a yearly federal contribution to the pension plan of $52.1 million through the year 2004.

Immediately after that, Kelly said, the district would be required to increase its annual contribution "dramatically" to cover interest costs. The mayor testified before the fiscal affairs subcommittee of the House Committee on the District of Columbia.

District Delegate Eleanor Holmes Norton, sponsor of legislation to eliminate the liability, she said is concerned about the effect of the liability on the district's credit position, especially if the city's fiscal situation continues to deteriorate.

Kelly called on Congress to pass Norton's bill and to accept a companion measure passed by the District of Columbia Council. Together, the two measures would require the district, its active employees, and the federal government to increase annual contributions to the plan. The legislation also would extend the federal contribution through 2035.

Under the legislation, the federal contribution would cover only 30% of the total unfunded liability, even though the U.S. General Accounting Office has said that about three-fourths of the liability stems from federal policy. "The issue becomes, what is realistic" for a joint solution, Kelly said.

"We need to put an end to the calamity that is this pension fund," D.C. Council Chairman David Clarke told the panel. "Unless the unfunded liability is eliminated, the retirement funds will never attain financial stability. The financial markets will continue to look askance at the district because they know city services will have to be cannibalized to keep paying pensions."

Rep. Pete Stark, D-Calif., the chairman of the full committee, said in a statement that while the federal government "bears significant responsibility" for closing the gap between pension receipts and obligations, the district first must establish a less generous program for new employees, improve the administration of the district retirement board, and ensure full and timely pension payments.

Clarke said he scheduled a July 12 hearing on a bill he is sponsoring to put new employees in a less costly, defined contribution plan.

Kelly said the board and council are reviewing recent task force recommendations to improve the retirement board, and she cited a court settlement reached last week by the district and the board over a payment schedule.

Such steps "are in the right direction," but "concrete changes must occur," Stark said.

Rep. Cass Ballenger of North Carolina, the subcommittee's ranking Republican, said, Congress needs to change the 1979 retirement law because it did not adequately address the district's pension funding needs.

However, Ballenger said that before action is taken he wants more information previously requested by Rep. Thomas Bliley, R-Va., from the GAO on alternatives to the Norton measure.

Joseph F. Delfico, director of income security issues in the GAO's health, education, and human services division, said his agency is concerned about the escalating federal commitment under the Norton bill, which could leave future federal budgets "burdened."

Delfico urged the subcommittee to consider instead a flat dollar contribution, which would cost the federal government less over the 40-year amortization period of 1996 through 2035.

But Robert Pohlman, the district's special projects director, said that "an actuarially sound funding plan requires some kind of increasing contribution" that is tied to inflation, pay raises or other rising costs over time.

Rating agencies and the investing public would discount the value of a flat contribution because over time, "they know it's not worth nearly as much as it is today," Pohlman said. The district would have to make up for any decline in the value of the federal contribution, which would be unacceptable, he said.

The unfunded liability has continued to grow since its transfer from the federal government, because the 1979 act specified a payment formula that was not designed to cover the full cost of ongoing benefits earned plus interest on the funded amount, Kelly and the GAO's Delfico said.

The district's current retirement costs are about 54% of payroll for the pension funds for police and fire fighters, teachers, and judges, Delfico said. Most local governments pay between 20% and 30%, he said. If the law is not changed, the district's contributions will "consume an ever-growing share of its budget revenues," from 8% in 1991 to about 15% of revenues in 2005, he said.

The GAO estimates that the total unfunded liability will reach $6.1 billion in 2004. The agency lowered the estimate from its November 1992 projection of a total $7.7 billion liability because of "favorable actuarial experience during the past few years," Delfico said.

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