Moody’s Investor Services said recent changes by the New York City Retirement Systems and California State Teachers’ Retirement System pensions are credit positives.
The two pension systems recently announced that they were lowering the assumed investment rate of return for the plans. This rate is used to calculate their unfunded pension liabilities.
“Although using a lower [rate] will require already stressed state and local governments to make larger payments, and creates additional budget pressure, it puts government on a more sustainable path to ultimately fully funding their pension commitments and is credit positive,” Moody’s stated.
“A lower investment return assumption also lessens the risk that future investment performance will fall short of assumed returns,” Moody’s said. “Higher assumed investment returns encourage pension systems to invest in riskier assets, with the result that returns are more volatile.”
“According to the National Association of State Retirement Administrators (NASRA), the most common assumed rate of return among large public pension plans is 8%, but between fiscal 2010 and fiscal 2011 plans have started to use lower rates,” Moody’s said.
On February 2, New York City lowered the assumed investment rate of return for the pension plan to 7.0% from 8.0%. It also replaced the frozen initial-liability actuarial funding method with the entry-age normal method.
“The city estimates the change will cost it an additional $1 billion annually (2.3% of estimated fiscal 2013 tax revenue), which it had already set aside in next year’s budget,” Moody’s said. While this will cause stress in the short term, in the long term this will lead to “greater stability” in the pension system.
Moody’s rates New York City Aa2.
On Feb. 2 the California system cut its assumed rate of return from 7.5% from 7.75%. That is the second reduction for the system since 2010. Lowering the rate adds $5.9 billion to its $56 billion unfunded liability.
The California pension system is the second largest in the U.S. Moody’s rates it Aa3.
California state government, teachers and school districts all contribute to the state plan. The change will increase their actuarially determined appropriate contribution.
However, California statutes set the actual contribution levels. The changed investment-return assumption “may place additional pressure on the Legislature to raise contribution rates to something closer to actuarially determined contributions in the future, or increase pressure to enact other pension-related reforms.”
The California plan had a 71% funded ratio as of June 30, 2010.