Colorado gets negative credit feedback from Moody's on pension funding decision

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Under budget pressure from the COVID-19 pandemic, Colorado lawmakers withheld a $225 million contribution to the state’s pension plan for the current fiscal year, a decision that will have negative implications for the state’s Aa1 credit rating, according to Moody’s Investors Service.

“The retreat from its plan to bolster poorly funded teacher and state employee pension systems is credit negative for the state and its local school districts, because it will simply defer the pension costs to later years and allow the associated unfunded liability to grow at a compounding rate of 7.25%,” said Moody’s analyst Thomas Aaron, citing the Colorado Public Employees Retirement Association’s assumed rate of investment return.

“Colorado's budget quandary also highlights the financial exposure of state governments to underfunded teacher pension systems generally, even where the obligations are not directly accounted for on the state balance sheet, due to their broad control over and support for K-12 education,” Aaron added.

The decision to hold the contribution comes two years after Colorado approved pension reforms designed to eliminate an unfunded $32 billion debt to public sector retirees.

After the pandemic hit in March, the Joint Budget Committee decided to eliminate the state’s $225 million annual payment to the pension for the budget year that began July 1. Because the pension’s money is invested over time, that would add an estimated $990 million to the pension’s long-term deficit.

Senate Bill 18-200 included higher employee contributions to PERA, a temporary cost of living allowance freeze and an annual cap on COLA increases. Government employer contribution rateswere increased slightly under SB 18-200, and the state also signaled its intention to make the additional $225 million annual supplemental contribution.

The decision to withhold this year’s contribution came as PERA suffered its worst year since the 2008 global financial crisis.

The PERA system has five divisions covering a variety of state, judicial, municipal and school district employees. The State and School Divisions are both significantly underfunded, and received the bulk of the supplemental state contributions in 2018 and 2019.

“Even with the benefit of supplemental contributions, state and local contributions to PERA nonetheless fell considerably below our ‘tread water’ indicator, which gauges the amount required to prevent unfunded liabilities from growing based on reported assumptions,” Aaron said.

The tread water gaps in 2019 for the State and School Divisions were 7% and 6% of payroll, respectively, amounts that would have been 10% and 9% without the supplemental contributions, Aaron said.

“Both divisions also have significantly negative non-investment cash flow relative to plan assets, even with the benefit of the supplemental contributions,” Aaron wrote.

NICF is contributions less benefits and expenses.

“Significantly negative NICF relative to plan assets can constrain asset accumulation, particularly in the event of investment return volatility,” the Moody’s report said. “In years with poor returns, pension systems that have very negative NICF must rely on selling assets to continue paying benefits, reducing the base upon which any subsequent returns may be earned.”

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Coronavirus Pension funds State budgets State of Colorado