Moody's: States' Adjusted Net Pension Liabilities Soaring

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WASHINGTON – The adjusted net pension liabilities of states totaled $1.25 trillion, or 119% of their revenue, in fiscal 2015 and were expected to grow by $50 billion at the beginning of this fiscal year, according to a report by Moody's Investors Service.

In "Medians – Low Returns, Weak Contributions Drive Growth of State Pension Liabilities," released Friday by Moody's, analysts attributed the increase in part to two factors. Pension contributions fell short in half of the states and the median return for pension plans plummeted to well below the average assumed investment return.

"Rising pension liabilities loom as a growing problem for many U.S. state governments as a result of states' insufficient contributions to pension plans, underperformance of invested assets and low interest rates among other factors," the credit analysts said in the report.

Moody's expected states' adjusted net pension liabilities (ANPL) to grow "dramatically" to $1.75 trillion by the beginning of fiscal 2017, on Oct. 1, because of projected weak investment returns in fiscal 2016 as well as interest rate hikes. The $1.25 trillion figure represents a significant increase from the under $1 trillion in total pension liabilities five years ago, the rating agency said.

The public pension funds' median return was 3.2% for the period ending June 2015 and 0.52% for the period ending June 2016, which Moody's said was "far below" the median target return of 7.5%.

"The median return for public pension plans in FY 2016 was 0.52% compared to an average assumed investment return of 7.5%," said Moody's vice president and senior credit officer Marcia Van Wagner, an author of the report. "We project that aggregate state ANPL will grow to $1.75 trillion in FY 2017 audits."

The fiscal 2015 numbers are the first to be based on compliance with the Government Accounting Standards Board's (GASB) Statement No. 68, the rules issued in June 2012 to improve accounting and financial reporting by state and local governments for pensions. The most recent figures establish a new baseline for states going forward, Moody's said.

Moody's stressed that fiscal 2015 pension data is not directly comparable with previous years because of the GASB standards.

Because of the adoption of GASB 68, most state pension data is reported with a six-to-twelve month lag and reflects data for 2014, according to Moody's analysts. Only 20 of 222 pension plans reported liabilities based on 2015 measurement dates.

The report also introduced a new "Tread Water" benchmark, which measures whether pension liabilities rose, fell or stayed the same -- "treaded water" -- during a fiscal year. The benchmark is based on whether each state's annual pension contribution covered both its service costs plus interest on the existing pension liability and whether states' annual pension contributions are enough to keep their unfunded net liability from growing.

The report's authors said that states were "evenly divided" between falling short and exceeding the benchmark in fiscal 2015.

Several states, including Kentucky, New Jersey, Illinois and Texas, were "notably" below the treading water mark in fiscal 2015, according to the report. For Kentucky to "tread water," it would have had to contribute an additional 7.5% of revenue to its pension plans, while Illinois would have had to contribute 6.8% of its revenue.

States with large contribution shortfalls will face increasing difficulties, the report warned.

"The difficulty such states have in adequately funding pensions is likely to worsen as contribution shortfalls exacerbate the impacts unfavorable market and demographic pressures," the analysts said.

South Dakota, Michigan, North Carolina and Utah exceeded their tread water contributions, but Moody's noted that many of the states exceeding this mark have ANPL percentages below the national median of 85%.

States with the highest pension burdens, the three-year average adjusted net pension liability as a percentage of state government revenue, remained consistent with previous years, the report found. Illinois, at 280%, had the highest pension burden in fiscal 2015, followed by Connecticut at 209%, Alaska at 179%, Kentucky at 162% and New Jersey at 157%.

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