Friday, September 20, 2013

Credit Risk in Provincial Pensions?

CBC reports, Moody's highlights unfunded pension risk in Quebec, N.L.:
Quebec and Newfoundland and Labrador have the largest unfunded pension liabilities among the Canadian provinces, according to Moody’s.

In a wide-ranging report on pension liabilities, the ratings agency found that Canadian provinces achieve good transparency in their pension plan reporting.

But underfunding of defined benefit pension plans for public-sector workers is a credit problem throughout the developed world, it said.

Alberta announced new rules earlier this week that will help it meet its pension obligations, including increased contributions from civil servants and less early retirement.

In Quebec and Newfoundland and Labrador “relatively large unfunded pension liabilities pose a challenge as they are likely to rise for multiple reasons,” Moody’s said in its report.
N.L. suffered after financial crisis

It estimates N.L.‘s ratio of funded liabilities to assets at 54 per cent in 2009, down from 77 per cent a year earlier. The province, rated Aa2 stable, took a substantial loss due to the 2008 financial crisis, Moody’s added and pointed out that deficits are forecast through 2014-15.

“Rising pension costs will add another challenge as the province tries to balance its budget. Newfoundland and Labrador has included pension reform as part of its 10-year sustainability plan, and has committed one-third of its annual surpluses, once achieved, toward the unfunded pension liability,” the report said.

Quebec’s ratio of funded liabilities to assets is 49.2 per cent and the province is rated Aa2 stable.

“Over the next few years, the province will face pressure to reduce both its relatively high debt burden and unfunded pension liability, within a context of having little room to increase new revenue given its status as a highly taxed Canadian jurisdiction,” Moody’s wrote.
Saskatchewan urged to pay more

It also urged Saskatchewan, which has a “pay-as-you-go” approach, to fully pay its annual pension requirement.

"Saskatchewan is in an unusual situation among Canadian provinces because it began to close all of its defined-benefit pension plans and transition to defined-contribution plans in the 1970s. Enough time has passed since these plans were closed to new members that Saskatchewan can reasonably forecast the required annual payments to members,” Moody’s said.

Provinces with the greatest unfunded pension liabilities should enact reforms to bring their costs down, the report said.

In 2012, Ontario had a small surplus in its pension funds and New Brunswick had the smallest burden, at 8.3 per cent.

The report also highlights the higher risk from pension liabilities among U.S. states. Unfunded pension liabilities are a major issue in settling Detroit's bankruptcy claims.
CTV also reports, Quebec, Newfoundland and Labrador face pension risk, says Moody's:
Quebec and Newfoundland and Labrador face the biggest pension risk among Canadian provinces due to large shortfalls in their pension funds, ratings agency Moody's says.

Moody's said Thursday that Saskatchewan also has a large pension deficit, but noted it has closed its defined-benefit plans and takes a pay-as-you-go approach to funding them.

"In both Quebec and in Newfoundland and Labrador, relatively large unfunded pension liabilities pose a challenge as they are likely to continue to rise for multiple reasons," Moody's analyst Michael Yake wrote in a report.

The report said average asset returns have been lower since 2008-09, while the discount rates which are used to calculate liabilities have fallen and the average life expectancy of pensioners is rising.

Saskatchewan and Newfoundland and Labrador had the highest ratio of unfunded liabilities to revenues at 55 per cent, while Quebec stood at 49 per cent, it said.

Ontario was the best positioned as the only province with a small surplus.

"We believe that credit risk tied to pensions is manageable because of the relatively small size of unfunded liabilities as a share of revenue and because we expect the provinces that are facing the highest liabilities to enact reforms," Yake wrote.

"If they do not, then credit risk could rise."

The provinces are not alone in facing the problem of underfunded pensions in the wake of the financial crisis.

Several of the biggest names in corporate Canada also face deficits in their employee pension plans, forcing them to put millions into the plans.

Canadian Pacific Railway (TSX:CP), Canadian National Railway (TSX:CNR), Bell Canada (TSX:BCE), MTS Allstream (TSX:MBT), Canada Post and NAV Canada have all lobbied Ottawa in hopes of gaining some measure of funding relief for their pension plans.

Air Canada struck a deal earlier this year to give it some help, but the relief came with rules that set limits on executive pay and prevent it from paying dividends to shareholders and buying back stock.
Earlier this week I discussed Alberta's sweeping pension reforms, stating that even though there is no crisis on the horizon, the demographic of their public sector work force requires the government to implement changes to lower pension costs.

There is no crisis in provincial pension plans but this report from Moody's serves as a warning that if pension costs are not brought under control, credit ratings of provinces will suffer a hit.

In the U.S., Moody's has cut ratings of states and cities over pensions and has highlighted that local governments have little control over pensions:
Many U.S. local governments have large pension liabilities, but few control the management, reforms and investments of their retirement plans, according to a report by Moody's Investors Service released on Monday.

Altogether, an estimated 75 percent of U.S. local government pensions are run through centrally administered plans, such as state "cost-sharing" systems, the ratings agency found in a sweeping survey of the public pension landscape that analyzed 8,000 local governments.

School districts in particular have little pension independence, it added, as all but a handful of school district pensions are run by cost-sharing plans. In addition, more than a dozen states pay part or all of school districts' annual pension contributions.

"The unfunded liabilities of U.S. municipal defined benefit pensions are significant, whether expressed in terms of balance sheet or annual budget," Moody's said in its report.

The aggregate net pension liabilities for the thousands of governments it studied are equivalent to 150 percent of their outstanding direct debt, Moody's found.

In budgetary terms, the approximate median pension liability for the governments is equivalent to 100 percent of annual operations.

State governments have generally received more scrutiny during the heated battles over public employees' retirement benefits.

But the Pew Center on the States at the beginning of the year found the most populous 61 U.S. cities are short by a collective $99 billion for pensions. The shortfall grew to $217 billion when other retiree promises, such as healthcare, were added.

Moody's noted "taxpayers can be responsible for the pension obligations of multiple levels of government," which in turn can cloud large aggregate pension exposure. For example, a resident of the city of Chicago could support 16 different pension plans.

Local pensions face other risks, as well, it said, such as exposure to changes in financial markets. Centrally administered plans have been moving out of fixed-income investments and into equities in the search for higher returns.

"In half of the states, many local governments of all types are directly linked to the asset performance of one or two large pension plans," Moody's said. "Management of this market risk is beyond the control of most local governments in cost-sharing plans, where they typically have little if any influence over investment policy or decisions."

As for the subsidies, states frequently pay at least part of pension contributions on behalf of school districts - New Jersey districts do not have to bear any pension costs or liabilities for their schools. The states may cut these payments as they grapple with their own budget and pension problems, Moody's said.

"How likely is the risk that on-behalf payments would be terminated? For many states, it may not be a matter of if but when," Moody's said, noting Maryland recently approved shifting pension costs to local schools.

Without a subsidy, Illinois school districts' unfunded pension liability would rise to more than 30 percent of their budgets compared to 2 percent currently, Moody's found.

However, Pennsylvania school districts' pension burden would double.

Moody's also said there are advantages to centralized plans, mainly in the form of lower administration costs.

Altogether, it found pension contributions may have more bearing on credit quality than local government control.

"A strong history of funding based on conservative financial assumptions confers low risk even if plan types are not conducive to local control of benefits or funding, or if state law constrains the ability to alter benefits," the report said.
The message is clear, provincial, state and local governments can no longer ignore their pension woes. If they do, their credit ratings will suffer and they will pay more to borrow.

In Canada, it's obvious that Ontario is in excellent shape when it comes to managing its public sector pension plans. Other provinces should follow its lead and look into how they can address their public pension deficits.

Below, Pierre Gattaz, chairman of Medef, France's biggest business lobby, discusses investor confidence, taxation and the French pension system. He speaks in Paris with Caroline Connan on Bloomberg Television's "The Pulse."