WASHINGTON — Pension risks for state and local governments will continue to be higher than those for corporations, Moody's Investors Service said in a report Thursday.
"Corporations have already made far more progress on reducing pension risks than state and local governments, and the difference is likely to grow given the slow and uneven pace of reform among municipal entities," Al Medioli, one of the authors of the report, said in a release.
Unfunded pension liabilities are higher for state and local governments than for corporations, relative to other debt. The risk levels for private and public sector pensions have been on diverging paths for 30 years and are likely to stay that way for at least the coming decade, Moody's said.
In the 1980s, corporations began embracing defined contribution plans as an alternative to defined benefit plans. However, states and localities have largely continued to focus on DB plans and have only recently begun introducing DC alternatives and other changes, the rating agency said.
"A defined contribution plan ..., of course, limits the pension sponsor's liability and risk to a fixed annual expense in the year the contribution is due," Moody's said in the report. "In contrast, the pension liability and risk of a defined benefit ... plan not only stays with the provider until an employee dies, but must be regularly funded and amortized when assumptions do not hold up."
As corporations have shifted to DC plans, they have engaged in "de-risking" their DB ones. They have moderated or frozen DB benefits and have bolstered the funding for their remaining DB exposures to the point where it is not uncommon for a company's DB plan to have a 95% funded level using conservative actuarial assumptions. Corporate ownership and regulatory and accounting standards have fostered pension de-risking for corporations, Moody's said.
In 2006, the Pension Protection Act was enacted. That law, which became effective in 2008, requires companies to plan for fully funded pension plans within seven years. The same year, the Financial Accounting Standards Board issued a statement that requires companies to record the funded status of pension and other post-employment benefit plans on their balance sheets.
While companies generally didn't start de-risking DB plans immediately after the financial crisis began, there became more interested in doing so as a result of sustained underfunding, drains on cash flows and increased investor scrutiny. Also, some rule changes in 2012 made de-risking cheaper.
In the early 2000s, many state and local governments actually expanded retiree benefits because they appeared to have overfunded pensions. "The negative budgetary and actuarial ramifications of enacting retroactive defined-benefit enhancements is hard to understate," Medioli said. "Not only are accrued liabilities immediately increased, but the singular action renders all previous years' normal costs inadequate, forcing current and future generations of stakeholders to pay the bill while providing retroactive discounts to the previous generation of taxpayers and employees."
Municipal governments do not have the same external incentives to mitigate pension risks that corporations have, the report said.
Municipalities don't face scrutiny from shareholders. Also, reforms being made to state and local government pensions are generally being driven by individual governments and not by accounting standards or external regulations, Moody's said. While the new pensions standards that the Governmental Accounting Standards Board approved in 2012 will require state and local governments to report a net pension liability in their financial statements, they do not prevent governments from basing their discount rate on the assumed investment rate of return.
