Will Pension Woes Unleash a Muni Debt Crisis?
U.S. states and localities have run up more than $2 trillion of unfunded pension liabilities, Moody's Investors Service said on Monday, citing data on plans offered by 8,500 local governments and over 14,000 individual entities.
The Wall Street credit agency said that according to its estimate, the total liabilities for fiscal 2010 were more than three times the amount reported by local governments.
"Pension liabilities are widely acknowledged to be understated," Moody's Managing Director Timothy Blake said in a statement. Most states end their fiscal years on June 30.
Investors in the $3.7 trillion municipal bond market are focused on whether states, counties, cities and towns can afford the pension benefits granted public workers.
The rising cost of public pensions has strained finances for cities around the country. Stockton, California, which last week became the biggest U.S. city to file for Chapter 9 protection, plans to cut employee compensation and retiree benefits by $11.2 million to help close its deficit.
Public pension benefits have become a flashpoint in elections around the country.
Since 2009, at least 43 states have tried to rein in costs. But many states spread the savings out over long periods.
Moody's is seeking public comment through the end of August on four major changes it plans to make in how it treats pension liabilities. The negative impact of the modifications - which will start taking effect in the fall - will hit local governments such as counties, cities and towns, as well as school districts, most heavily - unless Moody's significantly alters them after reviewing the public comments.
"Moody's expects the proposed pension adjustments to result in rating actions for local governments where the effect is outsized relative to their rating category, but no state rating changes are expected solely as a result of pursuing the adjustments now under consideration," it said.
Cities and counties are likely to see downgrades, Blake said.
That is partly because some liabilities in state pension plans that also cover localities will be allocated to the specific local governments. Currently, some of those liabilities might not be broken out by the individual city, town or school that is part of a state plan.
The liabilities of all public pension funds, for both states and localities, could leap, as Moody's will also consider a revision of the rate used to calculate them.
Currently, many public pension plans use the same rate - often 7.5 percent to 8.25 percent - for the assumed investment rate of return and the discount rate used to calculate liabilities.
Moody's would cut the discount rate to that of a high-grade long-term corporate bond index - which was 5.5 percent in 2010 and 2011.
The actuarial accrued liability would climb about 13 percent for each percentage point difference between 5.5 percent and whatever discount rate was used.
For example, a plan with a $10 billion liability based on an 8 percent discount rate would see that amount leap to $13.56 billion if a 5.5 percent rate were used.
Asset-smoothing, which enables pension plans to spread losses or gains over a number of years, will be abolished. Instead, pension fund assets will be valued based on the market value or the fair value on the actuarial reporting date, Moody's said.
Finally, yearly pension contributions will be adjusted on a common amortization period and in line with the three other modifications, Moody's said.
Some of the changes implemented by Moody's are in line with the new accounting rules for pension funds approved at the end of June by the Governmental Accounting Standards Board.
And Brian Chapatta of Bloomberg reports, Moody’s Pension Reporting Changes May Adjust Local Muni Ratings:
Moody’s Investors Service plans to adjust how it reports U.S. state and local government pension data, according to a request for comment released today.
The changes “likely would result in rating actions for those local governments where the adjusted liability is outsized for the rating category and without mitigating factors such as demonstrated flexibility to respond to higher fixed costs,” the New York-based ratings company said in the report.
The new criteria aren’t expected to result in rating changes for states, according to the report. In January, the company downgraded Illinois to A2, its lowest grade for a state, in part because of its “severe pension under-funding.”
The company is seeking comment on the usefulness of the changes in increasing comparability among state and local pensions, and in treating retirement liabilities similarly to debt. Moody’s will consider four main adjustments, according to the report.
Moody's is responding to the new GASB pension rules which will potentially roil public pension funds. It is unclear whether these new rules will unleash a muni debt crisis as cities and counties face downgrades.
Fallout from the recession continues to hobble state finances, particularly in states crippled by pensions they can't afford to pay.
Chief among them is Illinois, which has racked up the largest unfunded liability in the nation. Politicians there pledge to fix it.
In 2010, only one state, Wisconsin, had enough money in the bank to fund all of the retirement benefits it had promised its employees. The rest had collectively racked up nearly $1.5 trillion of pension debt, according to a recent study by the Pew Center on the States.
"What we're seeing is not the result of one bad year or two bad years — it's the result of a decade of bad choices in states like Illinois, where policymakers really have consistently fallen short of what they should have been doing," says David Draine, a senior researcher with Pew.
Draine says politicians are letting down not only the workers counting on those benefits, but also the taxpayers who fund them. The study also places Connecticut, Kentucky and Rhode Island in the bottom tier of states with the lowest percentage of funded pension liabilities.
But Illinois is the worst.
The gap between what Illinois promises employees in retirement benefits and what it has set aside to pay them is $83 billion. The state government would have to shut down for 2 1/2 years and use all of the tax money it collects to pay that off.
Draine says that leaves states like Illinois with few options.
"Well, it's going to find itself either having to make very tough tax increases, draconian cuts in services, or it's going to have to find money by cutting the benefits it's offering to current employees and retirees in painful and unpleasant ways," he says.
Already, Illinois has cut the benefits for newly hired teachers and state workers. And the threat that the state will come after veteran workers has led to an exodus of public employees like Brenda Allan.
After more than 23 years as a secretary at the University of Illinois-Springfield, Allan is calling it quits.
As she steps away from the retirement party being held in her honor, Allan says she had thought about retiring for a couple of years.
"But also there is the concern of, you know, what the General Assembly is doing and what impact that is going to have on both current and future retirees. What goes on down at the statehouse certainly has been a concern," she says.
Running Out Of Retirement Cards
Allan is not alone. In May, when legislators appeared poised to cut pension benefits, lines formed outside the State Employees' Retirement System offices in the capital as government workers put in their notices.
"It's a little bit humorous to me," Allan says. "The retirement card that I received today simply says 'thank you.' And the reason for that is because there are so many state employees and university people retiring within the city of Springfield that you cannot go into any store and buy a retirement card at this point."
Despite the fears, Illinois hasn't taken the big step yet. Democratic Gov. Pat Quinn says the crisis is real.
"We just simply cannot afford this. The squeeze is on," Quinn says.
This year, 15 percent of the budget is going toward pensions.
"Our allocations for education, for human services, for health care, for public safety — less and less of the percentage of our budget will go to those important causes if we don't reform our pension system," Quinn says.
Despite the governor's adamant tone, talks are now at a standstill. Democrats control the Legislature, and Republicans accuse them of stalling.
Given the money that unions contribute to lawmakers' campaigns, it's not surprising that in an election year legislators are in no hurry to cut benefits.
But waiting comes at an expense. It costs the state $12.6 million every day the state does nothing to address the pension crisis.
I'm amused at how all the talk is about cutting benefits. For years Illinois didn't top up the state pension fund and its governance was pathetic, which is what led to this mess. And now lawmakers are out to cut benefits.
Unfortunately, the situation isn't any better in the private sector. Benjamin Ruffel of aiCIO reports, US Pension Funding Slips Further:
Corporate pension underfunding in the United States grew markedly in the first half of 2012, and legislative relief offered by Congress could exacerbate pension deficits, consultancy Mercer has asserted.
The aggregate deficit facing pension plans sponsored by the S&P 1500 increased by $59 billion between December 31, 2011 and June 30, 2012, according to Mercer. The total figure at the end of June stood at $543 billion, representing a funded ratio of 74%, a drop from its previous ratio of 75% in December.
The funding issues stem less from ailing US equity markets, which bore respectable returns in June, but from falling discount rates that inflated liabilities. The drop in discount rates largely resulted from rating agency Moody’s action downgrading the credit rating of 15 major banks in late June. Many of those banks lost their AA credit ratings and consequently became excluded from yield curves used to set pension accounting discount rates.
Although applauded by plan sponsors and pension experts, the omnibus spending bill passed by Congress last week that relaxed funding requirements for corporate defined benefit plans will likewise aggravate underfunding. The bill will permit plans to employ a discount rate smoothed over a 25-year period instead of the current 24-month average. At the same time, Congress also upped the premiums that plans owe to the Pension Benefit Guaranty Corporation (PBGC).
“While these lower near-term contribution requirements will, rightly, be welcomed by many plan sponsors, the reduction in funding could lower overall funded status of US pension plans in the short term.” said Jonathan Barry, a partner in Mercer’s Retirement Risk and Finance business.
“All things being equal, that reduction in funding will reduce overall funded status from what it would otherwise have been had funding stabilization not been passed. We suggest that plan sponsors take the opportunity to review their pension contributions in light of both the new rules and their broader pension risk management framework. The increase in PBGC premiums that come with the new legislation certainly gives sponsors an incentive to keep their plans well funded.”
US pension plans are not alone in wrestling with sizeable underfunding challenges. This week, Aon Hewitt announced that the pension liabilities of the 350 largest companies listed on the London Stock Exchange had reached their highest level ever relative to market capitalization.
As you can see, the 'pension noose' is weighing down counties, cities, states and corporations. It's the slow motion freight train everyone wants to ignore until they can't.
And who will get squeezed as pension woes come home to roost? Mostly workers and retirees, but taxpayers too as they will see their taxes go up to fund basic services.
Something to ponder this 4th of July. As hedge fund titans rise and fall, collecting billions in fees from money allocated to them by public and private pension funds, workers and retirees will increasingly feel the squeeze from years of neglect and poorly managed pension funds.
Below, a Yahoo interview with Howard Friedman, statistician and United Nations health economist. In "The Measure of a Nation: How to Regain America's Competitive Edge and Boost Our Global Standing", he compares the United States to 13 other wealthy nations in five key categories: health, education, safety, democracy and equality. His analysis and conclusions are alarming: the U.S. has fallen far behind in most of these areas, causing the nation to become "the Dog" when juxtaposed to its Asian and Western European competitors.