CHICAGO — States are now suffering the effects of the decline in public pension fund assets from the market downturn of 2008, forcing some to reconsider benefit levels or shift spending at the expense of core services, Standard & Poor’s
Pension funding is receiving heightened attention now as some states struggle with the need to increase their contributions due to the drop in their retirement funds’ asset ratios.
The challenge comes as states are still struggling with a lackluster recovery in many key revenue sources and the end of federal stimulus aid.
The investment performance of a single year doesn’t typically translate into an immediate spike in funding needed in a state’s annual budget, because most pension funds smooth out investment gains or losses over a period of a few years.
However, analyst Robin Prunty warned: “The losses from 2008 are now translating to real budget pressure for states. We believe this will continue for a while.”
“This shortfall in assets is causing many states to re-think core services, programs, and benefit levels, including pensions,” said Prunty, a co-author of the report “Pension Funding and Policy Challenges Loom for U.S. States.”
In a review of data for fiscal 2008, the average funded ratio for state pensions dropped to below 80% from 83% in 2007, Standard & Poor’s found.
The average recorded in 2000 was 100%. Unfunded pension liabilities grew 24.2% to $457.8 billion in fiscal 2008 from $368.5 billion in 2007. At the same time, overall state debt rose 10.3% to $396 billion in 2008 from $359 billion in 2007.
Based on the agency’s review of pension data so far available for fiscal 2009, “we think it could look considerably worse,” Prunty warned.
The funded ratio is based on the difference in the actuarial value of assets compared to the actuarially accrued liabilities.
While funding schedules may be more flexible than a fixed liability like debt service, Standard & Poor’s said it considers pension liabilities and their funding burden an important factor in the review of a state’s creditworthiness that if not managed can limit ratings.
“If governments consistently ignore post-retirement benefits and underfunded contributions in the hope that future economic growth will bolster their finances sufficiently, they could be setting themselves up for greater hardship, in our view,” analysts wrote.
While analysts noted that states often are slow to act on pension funding issues, generally in recent years they have sought to better manage retirement costs or improve funding levels while avoiding dramatic benefit changes.
The most popular actions have included contribution rate changes, alterations to age and service, vesting requirements and reductions to some benefit levels. Some states face legal requirements to honor promised benefits to current employees and retirees.
The issue of pension funding levels likely will remain in the spotlight and spark ongoing debate among investors and government and pension officials, Standard & Poor’s said.
That’s due in part to the June release of preliminary views by the Governmental Accounting Standards Board on how to improve the effectiveness of the existing accounting and financial reporting standards for state and local governments.
The preliminary views relate only to accounting and financial reporting, and do not address how governments approach pension plan funding. The proposals stem from a research project on the topic launched in 2006 that found changes were needed to improve the transparency, consistency, and comparability of reported pension information.
The proposals would affect calculations and reporting on how pension benefits are earned, who is responsible for the obligations, how a liability would be measured, pension plan assumptions, and the frequency and timing of actuarial valuations. “We believe that significant changes could be on the horizon related to accounting and reporting and perhaps how a government funds it pension obligations,” Standard & Poor’s wrote.
The rating agency’s review is the latest in a stream of reports and commentary to come from market participants, fiscal experts and columnists focusing attention on the growing burden of public pension funds and their impact on government finances.
Herbert J. Sims & Co.’s director of credit analysis, Dick Larkin,
“There are so many reports out there that don’t really explain things to people who don’t understand how pension funds work. This is driving the municipal market into a tailspin. I wanted to put this in perspective,” Larkin said of his report.
“Unfunded liabilities have happened before and they are going to happen again. States will get through this. Yes, pension funding levels are a challenge and you have to address it, but it is not going to lead to insolvency in the near future,” he added.
Larkin notes that through the 1970s, governments avoided bankruptcy even though pension funding levels were the same or lower than today’s levels.
He also points to the recent analysis from the Pew Center on States that reported the average funded ratio of states plans was 84%. A ratio of above 80% is generally considered healthy.
The report suggests various options for governments — some of which have been adopted — to improve the funded ratios, including reduced benefits for new employees, a shift to defined contribution plans and increased government and employee contributions.
