Will Pension Woes Hurt State Ratings?

Lisa Lambert of Reuters reports, Pension issues may hurt state ratings: Moody's:

Some U.S. states face so much pressure to fund pensions for public employees that it could hurt their credit ratings, Moody's Investors Service said on Thursday.

As concerns grow over the financial health of many states after the 2007-2009 recession and how they will cut spending to cope, the ratings agency combined pension and debt data to rank the liabilities of each state.

In the past, Moody's evaluated credit risks from pensions and debt levels separately. Lower credit ratings could raise the costs to states of borrowing money.

Connecticut, Hawaii, Illinois, Kentucky, Massachusetts, Mississippi, New Jersey and Rhode Island, along with Puerto Rico, have the largest debt-and-pension loads, Moody's found.

Nebraska and South Dakota have the lowest.

"Large and growing debt and pension burdens have been, and will continue to be, contributing factors in rating changes," Moody's said.

Problems with pensions -- which states have underfunded by at least $700 billion -- include weak returns on investments, not enough money set aside, impending retirements of "Baby Boomers" born in the late 1940s through mid-1960s, and Americans living longer, Moody's said.

New York, Delaware and California are often cited for large debt burdens but do not have the highest combined long-term liabilities, Moody's analyst Ted Hampton said in a statement.

"In general, states' rankings for debt and pension combined parallel their rankings for debt alone," Hampton said but he added: "not all states with large debt burdens also suffer from weak pension funding."

IN THE TRILLIONS?

The $700 billion underfunded figure is a conservative estimate for how much money states will need to cover the pension promises they have made to their employees.

But $3 trillion could be nearer the mark, one study warned last year. States expect too generous a return on investments made by their pension funds, said the study by Joshua Rauh of the Kellogg School of Management at Northwestern University.

Regardless of the exact amount, states have to find a way to adequately fund pensions.

"More and more, it's going to take up a larger share of their ... budgets," said Kil Huh, director of research at Pew Center on the States, which has been closely following the pension issue.

Money flows from three major sources into pension funds: employee contributions, the employing governments and investment returns.

"Employee contributions have gone down and, at the same time, employer contributions because of the fiscal crisis haven't been there," Huh said.

Moody's, too, says the problem is getting bigger.

"Unfunded pension liabilities have grown more rapidly in recent years because of weaker-than-expected investment results, previous benefit enhancements and, in some states, failure to pay the full annual required contribution," the report said.

"Moreover, pension liabilities may be understated because of current governmental accounting standards," it added.

The Moody's report "will shed more light upon the states which have eliminated or underfunded their yearly contributions for pension liabilities simply as a way to manage their finances," said Thomson Reuters Senior Market Strategist Daniel Berger.

One dramatic solution to the pension problem would be allowing states to declare bankruptcy, which some congressional Republicans want. Then, they could renege on pension promises made to employees.

After being criticized for missing risks in the housing boom, Moody's is showing with this report it's "not asleep at the wheel" on the pension threat, said Richard Larkin, senior vice president and director of credit analysis at Herbert J Sims & Co. in New York.

But, the report also showed the liabilities are manageable, he added. For example, Moody's found Hawaii's pension-and-debt load is equal to 16.2 percent of its gross domestic product, the biggest proportion of all the states.

Even though the liabilities are in the billions of dollars, "when you compare them to GDP it's still low numbers," Larkin said.

"And it's still relatively much lower than these problem countries people keep comparing them to," he said, referring to recent fears that California or Illinois will soon be plunged into troubles similar to those Greece or Ireland are facing.

In a separate article, Simone Baribeau of Bloomberg reports, Moody's Says Massachussetts Among States With Highest Debt, Pension Burden:

Moody’s Investors Service provided a combined measurement of debt and pension liabilities for the first time to analyze U.S. states’ creditworthiness after “rapid” growth of their unfunded retirement obligations.

The joint figures released today make it easier to compare fixed costs among states and with corporate-bond issuers, Moody’s said. The company previously included pension liabilities separately in evaluating states. It revised municipal ratings in April to make them more compatible with corporates.

“Greater comparability and transparency” will come from the new metric, Robert A. Kurtter, managing director for public finances at New York-based Moody’s, said in a telephone interview. “In a corporation, you look at them together. As a government, we would look at them together also as the fixed costs that the government has to pay.”

Less than half the 50 state retirement systems had assets to pay for 80 percent of promised benefits in their 2009 fiscal years, according to data compiled by Bloomberg. Two years earlier, only 19 missed the mark. Illinois covered just 50.6 percent in 2009, the lowest ratio, which actuaries say shouldn’t be less than 80 percent.

Hawaii, Massachusetts and Connecticut are among the states with the largest combined debt and pension obligations relative to their economies and revenue, Moody’s said today.

Parallel Rankings

In general, states’ rankings for debt and pensions combined parallel their rankings for debt alone, it said. Hawaii, Massachusetts and Connecticut also have the largest ratios of bonded debt to personal income, Moody’s said.

“Not all states with large debt burdens also suffer from weak pension funding,” Ted Hampton, a Moody’s analyst, said in the release accompanying the report. New York, Delaware and California -- states with comparatively large debt burdens -- are not among the states with the highest combined long-term liabilities.”

Moody’s said that states may understate their pension liabilities and that pressure to fund retirements will continue to have a “negative impact” on state ratings.

“We’ve become more concerned about the unfunded pension liabilities and the costs they’re creating for governments at a time when they’re already stressed,” said Kurtter, who was among the authors of today’s report.

For some states, such as Illinois, which is rated A1 and has a negative outlook, growing debt and pension burdens have already contributed to rating changes, Moody’s said.

States’ control over revenue and spending may help them address the growth in pension liabilities, the report said. As a group, states are still “highly rated” at A1 or higher, it said, because of their tax and budget powers.

On its website, Moody's put out this press release:

A new report by Moody's Investors Service presents combined net tax-supported debt and pension liability figures for the U.S. states, providing a clearer view of how each factors into the evaluation of states' total current liabilities.

"Pensions have always had an important place in our analysis of states, but we looked separately at tax-supported bonds and pension funds in our published financial ratios," says Moody's analyst Ted Hampton. "Presenting combined debt and pension figures offers a more integrated -- and timely -- view of states' total obligations."

Given the level of fiscal stress being felt by most states and the prospects for sluggish economic growth and slow revenue recovery, pension funding pressures will continue to have a negative impact on state credit quality and state ratings. Moody's also recognizes that, as currently reported, pension liabilities may be understated.

Of the 50 states, those with the highest debt and pension funding needs include Connecticut, Hawaii, Massachusetts, and Illinois, the report finds.

"In general, states' rankings for debt and pension combined parallel their rankings for debt alone," says Hampton.

Hawaii, Massachusetts, and Connecticut -- the three states with the largest ratios of bonded debt to personal income -- are also among states with the largest combined debt and pension obligations relative to their economies and revenues.

"Not all states with large debt burdens also suffer from weak pension funding, however," Moody's Hampton adds. "New York, Delaware, and California -- states with comparatively large debt burdens -- are not among the states with the highest combined long-term liabilities."

Some states, notably Maryland and South Carolina, have strong credit ratings despite relatively high debt and pension burdens, underscoring that these liabilities are only one of many factors that contribute to state ratings.

Moody's presentation of combined debt and pension figures as part of a more integrated view of states' total obligations follows a period of rapid growth in unfunded pension liabilities.

"Pension underfunding has been driven by weaker-than-expected investment results, previous benefit enhancements, and, in some states, failure to pay the annual required contribution to the pension fund," says Hampton. "Demographic factors -- including the retirement of Baby Boom-generation state employees and beneficiaries' increasing life expectancy -- are also adding to liabilities."

Moody's says that the evaluation of current and projected pension liabilities is an important area of focus in its rating reviews. For some states, such as Illinois, which is rated A1 and has a negative outlook, large and growing debt and pension burdens have already contributed to rating changes.

States as a group are highly rated -- currently A1 or higher -- because of their control over revenue and spending that may help address the recent growth in their pension liabilities.

"Many states are beginning to respond to this growing challenge by increasing contribution requirements, raising minimum retirement ages, and undertaking other reforms," Moody's Hampton concludes.

The report, "Combining Debt and Pension Liabilities of U.S. States Enhances Comparability," is available at moodys.com.

Moody's earlier reports on public pension liabilities covered specific aspects of the subject area, including increasing government pension contributions, the cost pressures on state and local governments, and the impact on pension funding of stock market declines. The effect of pension obligations on state and local government credit ratings will be the subject of further reports from the rating agency in coming months.

Unfunded pension liabilities will continue wreaking havoc on state finances, forcing politicians to take bold measures to shore up these pension plans. I welcome Moody's new initiative focusing on current and projected pension liabilities and taking a more integrated approach in evaluating state finances. I would take it a step further and start evaluating all aspects of pension fund governance, analyzing which state pension plans are following best practices and which are most vulnerable to further deterioration in the future.